普爾特房屋 (PHM) 2018 Q4 法說會逐字稿

Ladies and gentlemen, good day, and welcome to the PulteGroup's Q4 2018 Quarterly Earnings Conference Call.

Today's conference is being recorded.

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

Please go ahead, sir.

Great.

Thank you, Abby, and good morning.

I want to welcome everyone to this morning's call to discuss PulteGroup's fourth quarter 2018 operating and financial results.

I'm joined this morning by Ryan Marshall, President and CEO; Bob O’Shaughnessy, Executive Vice President and CFO; and Jim Ossowski, Senior Vice President, Finance.

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

We'll also post a replay of today's call to the website a little later today.

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

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

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

Before I turn the call over to Ryan, I also want to alert everyone that today's presentation includes forward-looking statements about the company's expected future performance.

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

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

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

Now let me turn the call over to Ryan.

Ryan?

Thanks, Jim, and good morning.

With our strong fourth quarter results now reported, we complete a very positive year in which we achieved critical operating and financial goals against which we measure the performance of our business.

Included in the key metrics we track is our ability to invest in and purposely grow our business.

And we've talked about on prior calls that we look to grow our business consistent with or slightly faster than the overall new-home market.

With 2018 closings up 10% to just over 23,000 homes, we achieved that objective last year.

10% more closings in combination with an 8% increase in average selling price allowed PulteGroup to drive an 18% or $1.5 billion gain in annual homebuilding revenues to $9.8 billion.

Our 2018 revenues are the fourth highest in the history of PulteGroup and by far the highest in the past dozen years, so we appreciate the effort required to achieve these results.

For PulteGroup, it's not just about growth, but forecast -- but focusing on profitable growth, which is why I'd also highlight our industry-leading gross margins.

While we do not run the business to achieve a specific gross margin, we understand its power in driving earnings.

Having said that, we are continuing to run the business with a view towards generating high returns on invested capital by balancing price and pace on a community-by-community basis.

The 18% increase in homebuilding revenues also allowed us to realize meaningful overhead leverage, which in combination with our more efficient homebuilding operations and lower share count drove the company's significant earnings gains in 2018.

PulteGroup's success this past year also reflects the tremendous time, effort and skill provided by all of our employees.

Employees, who, in addition to building great homes, have built incredible culture that ranks among the top 5% of companies globally, as measured by Gallup.

I want to offer a sincere thank you to each of them for delivering a great experience to our homebuyers and our shareholders.

In addition to a lot of hard work, our growth in 2018 also reflects ongoing investments we've been making in the business.

Over the past 4 years, we have invested over $10 billion in land acquisition and development, but have done so with a clear focus on building a more efficient land pipeline.

The result is that we've successfully shortened the duration of our own lots, which is now below 4 years, while simultaneously increasing option lots, which now represents 40% of our controlled lot position.

I would also point out that with roughly 54% of 2018's approved lots being controlled via option, we expect to make further progress going forward.

To put our current land portfolio in perspective, at the end of 2014, we owned almost 6 years of land with only 1/4 of the pipeline held via option.

We firmly believe that our more efficient land pipeline can help support high returns while reducing the market risk associated with owning longer land positions.

Another benefit of our disciplined land acquisition process is the capital efficiency it has helped us generate, which allows us to be balanced and more shareholder friendly with our overall capital allocation.

In 2018, we used excess capital to repurchase nearly $300 million of PulteGroup's common shares, while also paying out over $100 million in dividends.

Since reestablishing our dividend and share repurchase programs in 2013, we have returned nearly $3 billion of capital to shareholders, while retiring approximately 31% of our outstanding shares.

As we have stated, we are managing our business against the defined objectives of growing pretax income while working to deliver appropriate risk-adjusted returns on invested capital over the housing cycle.

Our 2018 results demonstrate that we continue to successfully execute this disciplined and balanced approach to the business and that we and shareholders continue to reap the benefits.

As strong as our 2018 operating and financial performance was, the reality is that the numbers reflect an outstanding spring selling season followed by an industry-wide softening of demand, beginning late in the second quarter.

To widely varying degrees, this change has been followed across all buyer groups and most, if not all markets, across the country.

This is setting up 2019 to be more of a challenging year.

Many point to the rise in interest rates that accelerated in Q2 of 2018 as the trigger for the changing consumer behavior.

I think the rise in interest rates may be better views -- better viewed as the proverbial final straw rather than a trigger as it came on top of several years of home-price appreciation and growing affordability challenges.

The combination of these things, coupled with global trade and geopolitical unrest, was enough to move potential buyers to the sidelines and create a general sense of uncertainty.

Consistent with much of the commentary issued over the past several weeks, we too experienced a sequential improvement in qualified buyer traffic to our communities as interest rates moved lower.

On a per store basis, traffic was lower in October and November compared with last year, but the trend turned positive in December.

Given this is the seasonally slow part of the year, however, I would encourage us all not to read too much into the data.

Thinking about 2019, there is less certainty about demand heading into this spring selling season than the industry has experienced in a number of years.

We have seen forecasts for U.S. new-home sales ranging from up 5% or more to down 5% or more.

If demand conditions accelerate and absorption rates improve, we have the communities, inventory and lots available to meet that demand.

At the same time, we have the balance sheet to continue investing in the growth of the business.

If, however, demand in the upcoming spring selling season remains soft, we will work closely with our local operators in assessing each community's prospects, with an eye toward delivering the best risk-adjusted returns.

For some communities, this could mean working to drive greater absorption pace, while others may look to maintain price and margins.

There is no one-size-fits-all answer for how each community will be run but rather a thoughtful, balanced approach to managing the company in its entirety.

It is worth highlighting that we remain constructive on the market.

As a result, we believe there is potential for improving or at least more stable demand due to the fact that broader -- the broader operating environment remains strong in terms of a growing economy, great jobs numbers, rising wages and continued high levels of consumer confidence.

Fortunately and finally, I feel confident about how our business is positioned to navigate the year however it plays out.

We have a great team, great product and great assets, and the actions that we've taken over the past few years to shorten the duration of our land pipeline, to increase options, to drive our margin performance and to enhance our balance sheet puts us in a position to operate from a position of strength.

Let me now turn the call over to Bob for a detailed review of the quarter.

Bob?

Thanks, Ryan, and good morning, everyone.

PulteGroup completed 2018 by posting another quarter of strong financial results.

As noted in this morning's press release, the company's reported fourth quarter numbers were impacted by several significant items.

In my remarks, I will be addressing both our reported and our adjusted results.

As Jim mentioned, we've provided a reconciliation of our reported to our adjusted results in the press release we issued this morning as well as in the slides we posted in connection with this webcast.

Consistent with recent commentary related to the housing market, we experienced softer demand during the fourth quarter relative to the same period last year, and to our third quarter this year on a seasonally adjusted basis.

For the quarter, we reported net signups of 4,267 homes, which is down 11% from last year.

As has been the case for much of 2018, our active adult business outperformed our more traditional communities with our active adult communities up 1%, while first-time and move-up communities were both lower by 15%.

While signups were lower, same-store traffic trends improved in the quarter -- improved as the quarter progressed and we sold more houses in December than in November.

These data points reinforce the view that buyer interests remain high and that we may be facing more of a temporary pause in demand as markets and buyers reset.

However, as Ryan stated, the fourth quarter is our slowest quarter seasonally, so we aren't reading too much into the recent results.

As with net signups, our absorption pace has also slowed in the fourth quarter, declining 14% compared with the prior year.

Absorption paces were lower across each buyer group, decreasing 24% among first-time buyers, 13% among move-up buyers and 9% among active adult buyers.

Although buyers were slower to sign contracts in the fourth quarter, we entered the quarter with a large backlog of sold homes, which allowed us to deliver excellent financial results in the period.

Home building revenues in the quarter increased 6% over 2017 to $2.9 billion.

The higher revenues for the quarter were the result of a 5%, or $20,000, increase in the average sales price of homes closed to $430,000, along with a 1% increase in closings to 6,709 homes.

The 5% increase in our average sales price for the period reflects price increases realized across all buyer groups.

For the quarter, average sales prices among first-time buyers was up 15% over last year, to $375,000; while our ASP for move-up buyers increased just under 1%, to $477,000; and our active adult prices gained 4%, to $405,000.

The 15% increase in ASP among first-time buyers was driven by price increases realized across a number of markets, along with additional closings from certain communities in the Bay Area of Northern California, which sell at much higher prices.

In the quarter, closings by buyer group break down as follows: 27% were first time, 46% move-up and 27% active adult, which is comparable to last year's results.

We ended the year with a total of 9,491 homes under construction, of which 6,245 or 66% were sold units and 3,246 or 34% were spec.

I'd like to point out that we elected to allow spec production to run higher than in recent quarters to ensure access to production trades and to position communities heading into 2019.

This is a tactical decision as we expect spec production will come back in line as the year progresses.

With 715 finished specs, still less than 1 per community, we remain comfortable with our production ahead of the spring selling season and like the opportunity these units provide to meet any buyer demand for a quicker close.

Our reported gross margin for the fourth quarter of 21.5% includes $67 million of land impairments, driven primarily by a project in our mid-Atlantic market.

Excluding the impact of impairments, our adjusted fourth quarter gross margin was 23.8%, which is consistent with last year's adjusted gross margin.

The mid-Atlantic project we impaired relates to an asset that we acquired in 2005, with the expectation it would ultimately be entitled for more than 1,000 lots.

Now 14 years later, the project has still not received final approvals and recent court rulings point to the anticipated density being cut by almost 2/3.

It has been and remains our intention to build on this site, but the economics associated with the expected ultimate approvals did not support the carrying value of our investment.

This is yet another reminder of why we no longer buy on entitled land.

In addition to the land impairment charges related to this project, we also wrote off approximately $5 million of deposits related to a contiguous parcel we controlled as part of that project as that element of the project was no longer deemed economical in today's market at the newly projected densities.

That charge has been reflected in other income expense on our income statement.

During the quarter, we also recorded approximately $7 million of costs to reflect higher post-closing performance obligations related to a previously sold asset, which has been reflected in land sale cost of revenues on our income statement.

While market conditions are more competitive, we continue to successfully execute key sales practices, which have helped drive our revenue and margin performance over the years.

This includes our strategic pricing methodology, through which we seek to ensure that we are priced competitively in the market while continuing to realize value from options and lot premiums.

In the fourth quarter, our option revenues and lot premiums increased 8.3% or approximately $6,400 over last year to more than $83,000 per home.

Sales discounts in the fourth quarter came in just under $15,000 per home or about 3.3% of average sales price.

This is an increase of 10 basis points over the fourth quarter of last year and is up 30 basis points from the third quarter of this year.

Reported SG&A expense for the fourth quarter was $292 million or 10.1% of home sale revenues.

Our SG&A in the quarter reflects modest increases in incentive compensation and sales commissions.

Fourth quarter 2017 SG&A expense of $202 million or 7.4% of home sale revenues included a $66 million pretax benefit from insurance-related adjustments.

Last year's adjusted SG&A expenses was $268 million, or 9.8% of home sale revenues.

In the fourth quarter, our financial services business reported pretax income of $5 million compared with $23 million in the fourth quarter of last year.

In the current year quarter, we reported a $16 million adjustment to our mortgage origination reserves as we settled the claim tied to mortgage issues -- mortgages issued prior to the last housing collapse.

Beyond this adjustment, our financial services business continued to operate in a competitive market environment, which impacted our capture rate and margins.

In the fourth quarter, our capture rate declined to 77% from 81% last year.

Our reported income tax expense for the fourth quarter was $92 million, which represents an effective tax rate of 27.9%.

The higher rate relative to our guide reflects $14.1 million of expense related to a valuation allowance against certain deferred tax assets and a $6.9 million benefit related to a tax method change.

Looking ahead to 2019, we expect our tax rate to be approximately 25.3%.

For the quarter, our reported net income was $238 million compared with $77 million last year.

On an adjusted basis, our fourth quarter 2018 net income increased 24% over last year to $314 million.

Adjusted earnings per share for the fourth quarter totaled $1.11, which is an increase of 31% over the fourth quarter of last year.

Diluted EPS for the quarter was calculated using approximately 280 million shares, which is a decrease of 13 million shares, or 4%, from the fourth quarter of last year.

The lower share count was driven primarily by the company's ongoing share repurchase program, pursuant to which we bought back 10.9 million shares in 2018 at a cost of $295 million or $27 per share.

These figures include 5.1 million shares repurchased in the fourth quarter for $122 million or $24.13 per share.

We ended 2018 with $1.1 billion of cash and a debt-to-total-capital ratio of 39%, which is down from 42% at the end of last year.

On a net basis, our debt-to-capital ratio fell to 28%.

Let me conclude my review of the fourth quarter by providing a couple of additional data points on our homebuilding operations.

During the fourth quarter, we operated out of 815 communities, which is up 3% over last year and in line with our guidance.

Based on anticipated community openings and closings, we expect community account in 2019 to be comparable with 2018.

In the quarter, we invested $335 million in land acquisition and approved 6,400 lots for purchase.

Of the lots approved in the fourth quarter, 55% were under some form of option.

For the full year, we invested $1.2 billion of land acquisition, which is up 13% over last year, and approved 28,000 lots.

We continue to focus on smaller, faster-turning transactions as the average project size was approximately 140 lots.

At present, we expect our land acquisition spend for 2019 to be approximately $1.2 billion, which is comparable with the last year.

We will also work to use option transactions when they support our objectives of enhancing returns or lowering risk.

We ended 2018 with approximately 150,000 lots under control, of which 40% were controlled via option.

With 90,000 lots owned, we continue to carry less than 4 years of owned land.

With 54% of the lots we approved in 2018 being under option, we are successfully executing against our strategy of wanting to own 3 years of land or less.

We continue to evolve a shorter, faster-turning land bank, which can help to improve asset turns and overall returns on invested capital while helping to lower market risks.

We believe this approach grows increasingly valuable considering recent demand volatility and the dual threats of higher interest rates and/or a slowing, which could impact overall housing demand.

As noted, our traffic numbers picked up over the past several weeks and our December signups increased on a sequential basis from November, which are positives.

However, given the uncertainties in the market and the broader economy, we will only be providing guidance with respect to PulteGroup's expected first quarter results at this time.

Based on our production pipeline of 9,500 homes under construction, we expect Q1 2019 deliveries to be in the range of 4,300 to 4,600 homes, with an average sales price of approximately $420,000.

We continue to execute against our return-focused business model, which means that we must remain price competitive in the markets we serve.

As such, we took actions to adjust our selling efforts as market conditions grew increasingly competitive in the latter half of 2018.

Given these adjustments and the lingering impact of higher lumber costs, we currently expect first quarter gross margins to be in the range of 22% to 22.5%.

As a result of our lower volumes and pricing, we expect to realize less overhead leverage with SG&A as a percent of homebuilding revenues likely approaching 13.5% in the first quarter.

And finally, as I noted earlier, we expect our effective tax rate in 2019 to be approximately 25.3%.

In conclusion, the company's strong operating and financial performance in the past year has us well positioned heading into 2019.

Now let me turn the call over to Ryan for a few final comments.

Ryan?

Thanks, Bob.

As I discussed, the softer demand conditions evident in late Q2 and Q3 continued into Q4.

And while we have seen better traffic over the past several weeks, it is still too early to get an accurate read on what this means for the spring selling season.

In terms of regional commentary about the quarter, like the weather, demand in the fourth quarter got warmer as you moved from north to south, both along the eastern and middle thirds of the country.

Demand in our Northeast and Midwest markets was challenged but showed some improvement in December.

We saw the same pattern across our Texas markets, while Florida was arguably the country's best area of demand.

And finally out West, conditions are generally unchanged, with higher price-point communities in Washington and Northern California seeing slower absorption paces, while demand in Phoenix is holding up reasonably well.

So as we head into 2019, in what will likely be a more challenging year, let me just quickly check off a few reasons why I'm confident in PulteGroup's competitive position.

We have a broad operating footprint, but with sufficient scale in the markets in which we operate, we have a diversified customer base, although we are biased towards the more financially capable buyer groups.

We have built a supportive and efficient land pipeline, but without having gotten overly aggressive with recent land spend.

We have a strong balance sheet, with tremendous financial flexibility.

And maybe our biggest strength, we have an experienced leadership team, including our area and division presidents who know how to operate in changing market conditions.

Let me conclude on that comment and turn the call back to Jim Zeumer.

Jim?

Great, thank you, Ryan.

We will open the call for questions so we can speak with as many participants as possible during the remaining time of this call.

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

(Operator Instructions) We'll take our first question from Mike Dahl, RBC Capital Markets.

I'd like to start with just the discussion around the current sales environment.

It sounds like you made the decision -- and understanding it's community by community, but given the competitive pressures to incentivize a bit more, curious to get your thoughts on a couple of things.

First, to the extent that you're incentivizing, what types of incentives are you finding to be most effective at this point?

And tied into that, to what extent is -- I think, Bob, you mentioned the commissions in SG&A, to what extent are higher co-brokers influencing your SG&A?

Mike, it's Ryan.

Thanks for the question.

And I think you hit the nail right on the head.

It's really on a -- it's a community-by-community basis where we're making those decisions and our operators are quite skilled at evaluating the competitive set that we operate in within that specific ZIP code, if you will, or within that specific municipality, and so we're evaluating that.

In terms of what's most effective, I think we've been quite clear to say that affordability is the challenge and so the incentives that we can provide that help to alleviate pressure around affordability are the things that are being most effective.

We talked about -- I talked about it extensively on our last call, where our general view is base price is the last thing that we like to adjust.

So we try to do it through other forms of incentives to hopefully create urgency and alleviate some of the pressure that we've -- that the buyers have felt around affordability.

You saw our total discounts tick up a little teeny bit, but for the most part, I think, we have been able to do it in a variety of other ways to create little bit of pressure relief on the affordability side.

I'll let Bob talk about what we saw in the SG&A from added commissions.

Yes, Mike, we obviously -- we're working with the broker community.

We saw probably 10 basis points of incremental SG&A cost around co-broke.

Got it.

Okay.

That's helpful.

As far as my second question and just a follow-up on the gross margins, just given your build cycle, given -- while you have increased your specs a bit, it's still relatively low.

I understand that you're only giving the first quarter guidance, but if we think about what the actions are that you've taken over the past several months to alleviate the affordability to increase incentives a bit, is this one quarter -- 1Q gross margin fully reflective of the steps you've taken?

Or if current market conditions persist, would you expect that it might take another quarter or so to see that impact fully flow through, so that 22% to 22.5% gross margin could step a bit lower?

Mike, fair question.

We're not giving guidance beyond the first quarter.

So with that having been said, certainly the sales environment over the next, call it, 2 to 3 months will matter to that.

Impacting our margins, obviously, will be lumber costs.

We are still feeling the spike in pricing through the middle of the year, so that's impacting our first and, to a degree, second quarter.

That will be a relative tailwind as we get to the back half of the year.

And the other thing that's impacting our margins in this quarter -- the first quarter is interest expense.

So if you think about our interest expense, we did some fairly significant financing activities back in 2016.

2018 is really the first year where our total capitalized interest is equal to our expense.

So we're feeling a little bit relative drag on margin.

You could see it, for instance, in this most recent quarter.

It was probably 50 or 60 basis points.

It'll be less next year.

It's probably 20 or 30 basis points of the margin decline that you see in the first quarter relative to the prior year.

So we had a couple of things moving around in there.

We'll take our next question from John Lovallo from Bank of America.

The first one, you guys have announced recently the expansion of Centex into a few new markets.

I guess the question is how quickly can this effort be accelerated given your current land position?

And do you see this as an appropriate strategy of pushing more into Centex here?

Yes, John, it's Ryan.

Thanks for the question and if I take you back to 2016, the fall of 2016, one of the first earnings calls that I was on, we talked about some of the shifts that we were making inside of the company to rebalance our portfolio and serve all consumer groups.

We indicated that it would be a subtle shift, where we wanted to move about 5 points of market share from our move-up buyer into the more affordable price points.

We wanted to do it the right way, though, John, and so we've intentionally gone out and targeted land parcels that will efficiently and effectively allow us to put a more affordable product on the ground.

Certainly, we could have taken existing parcels and put more affordable product there to kind of satisfy a metric, but it's just on the way that we think about running the business.

We are in this for the long term.

We have stated over and over again we are looking to drive the best possible economic outcome for our shareholders.

And specific to your question about being more affordable, I think that means you go out and you target the right pieces of land to do it the right way.

What I'd highlight for you, John, is that about 33%, 34% of the land that we have under control is specifically targeted to our first-time buyer group.

So while the closings today only represent about 27% of our closing volume, we see that on the go-forward inching closer and closer to what we actually have controlled as a total percentage of our overall land portfolio.

Okay, that's encouraging.

Maybe along the same lines, do you guys have any ability to reduce square footage within your existing communities to kind of help meet this affordability challenges?

Yes, we think we're already there today, John.

We offer really good flexibility within our existing product lineup that allows customers to kind of go up and down based on needs.

We've got a number of structural options that allow you to take an 1,800 square foot floor plan, as an example, and you can add on a loft or you can stick right with the 1,800 square foot floor plan, as an example.

So I think what we're seeing from buyers the way that they're currently buying is they are still buying the square footage that they need to satisfy their family dynamic.

They may be taking less options in cabinets or countertops or flooring upgrades to help manage the affordability pinch, but we have not seen buyers go all the way to the bottom end of our product lineup, which I think would tell you that the way we are covering the range of square footage is appropriate.

So if we were to go there and we have in prior cycles, it takes some time.

It's not just a call the ball and you move to a low square footage.

There's obviously entitlement and permitting things that have got to be done with cities.

So something that we're capable of doing.

If we felt like the market was going there, we'd certainly undertake the efforts to do that.

But our view, and you heard me say kind of in my prepared remarks, we remain constructive on the market, and we think the way we're positioned today, for the most part, is correct.

We'll take our next question from Alan Ratner with Zelman & Associates.

So first question on the traffic commentary as far as that's seen some improvement there in December.

Were there any particular price points or markets where that was most evident and has that trend continued on a year-over-year basis thus far into January?

Yes, Alan, we saw really across all the markets that we operate in so I wouldn't highlight lawn as being an outlier, which was a general improvement, which we take as a sign and is part of the reason that we try to be a tad optimistic about what we've seen in terms of traffic patterns, because it is a pretty widespread improvement.

And the trends have continued into January.

Similar to what we've said in December, the first 2 or 3 weeks of January are typically the very early stages of the spring selling season, and we don't see that typical spring selling pick up until after, really, the Super Bowl.

First part of February is when we see things officially kick in with spring selling season.

Okay, that's helpful.

Second question, I think the discounting disclosures you gave, I believe, is on closings.

So I was curious if you have that trend what it looks like on orders that was -- that were placed in the quarter.

And I guess just thinking about the spring, I fully appreciate the community-by-community discussion, but how would you articulate the strategy?

I mean, we've heard from a few other builders that effectively say definitively that gross margin is going to be the plug and it's important to keep the volume machine running.

So how would you characterize your overarching strategy heading into the spring when you think about what you're going to prioritize pace over price?

Alan, it's Bob.

We historically haven't given color on the actual sales that we've recorded.

We will give ASPs, but I think what you should think about is in terms of the guide we gave for the first quarter margin.

Certainly, we are seeing some margin erosion as a result of the sales environment that we saw in this -- what we highlighted in the prepared remarks was the back half of the year.

That's -- if we've got all-in a 5-month build cycle, you've got most of the third quarter embodied -- sorry, third and fourth embodied in that guide that we've given.

So that should give you some insight into the discounting we've had to do.

And Alan, just -- in terms of your question about what will we prioritize, probably I'm going to sound a little bit like a broken record, but we will continue to make pace and price decisions on a community-by-community basis and do it with an eye toward what we believe gives us the most favorable economic outcome.

Certainly, your comment about keeping the production machine going factors into that overall equation.

We are a production builder.

You've heard me say in the last couple of conference calls that volume matters and it does to us and it certainly does to our competitors.

Trade, we're all competing for a limited number of trades and the ability to keep a consistent production volume going in our communities is a big deal.

It was part of the reason that we -- it was part of the reason that you saw us make the tactical decision to increase our spec production just a little teeny bit.

The other thing that we think about too just from an overhead efficiency standpoint is making sure that if we accelerate pace that we actually have a new community to move into.

So is the land pipeline positioned such that if we close out earlier, you can move the team to the next location?

So those are all things that we take into consideration as we go through that community-by-community analysis.

I think what you've seen from us is a consistent and balanced view, where we have continued to work to drive the volume in the right spots.

But we've maintained some level of the superior gross margin profile that we've worked to build over time.

But we haven't, with a single eye or a single vision, held onto it.

You've seen some of that erode as we work to be competitive.

We'll take our next question from Stephen Kim with Evercore ISI.

I guess my first question relates to the quick move-in home commentary.

I think, Ryan, you just mentioned you increased your specs just a teeny little bit.

When we've been out in the field, we've noticed that folks -- customers have been a little reluctant to pay up for rate locks going out much more than a few months, and so the biggest amount of activity or demand has been on homes that they can move into relatively quickly without having to pay for such a long rate lock.

I was curious, therefore, to what degree doing more specs to maybe take advantage of buyer demand and also you mentioned some labor efficiencies, whether you thought that there may be some opportunity to make this a little bit more of a lasting change?

And just get a sense for how you're thinking about this spec activity?

Is it purely temporary or perhaps maybe something that might be more lasting?

Stephen, I would expect this to be temporary from us.

We have done extensive work and feel that we end up with a better long-term outcome by running more of a build-to-order model, and I think that's what you should continue to expect to see from us.

I think we have got other tools that we have effectively used with rate buydowns and longer-term rate locks that allow us to give the customers that are sensitive to interest rate fluctuations enough protection to give them confidence to buy.

So I think you'll see us, over the course of the next several months and few quarters, revert back to our typical spec cadence.

Okay.

And -- that's helpful.

And then regarding the comments you've made regarding the spring selling season or the preseason here thus far.

I think you mentioned that traffic improved in the last several weeks, a little bit too early to make a call and all that.

I was curious if your -- and you also mentioned you're still constructive on the market.

So a two-part question here.

Regarding your comments about the tone of business and on the traffic side, is it your view that the data you've seen on traffic has been a little too choppy to have conviction around the direction things are going?

And has maybe there been less interest reflected in deposits than there has been in traffic?

Has that -- is that a part of your view that maybe it's a little too early to make a call?

And secondly, regarding your comments about being still constructive on the market, I'm wondering how much this constructiveness is a reflection of maybe seeing some strength in December and January, and if there's anything that you might see in the next month or 2 that would make you less constructive so that when we speak to you next time, you would be less constructive than you are today?

Well, I'm going to politely probably take a pass on the last part of that question because I think it would be asking me to peer into a crystal ball.

So -- we've obviously got a number of scenarios that we look at here, Stephen, but I'll probably avoid rolling many of those out on this call.

In terms of kind of traffic and what's happened and why -- and the reasons why we're constructive, I think that's very relevant conversation and question.

What I'd highlight is on a same-store basis adjusting for community count, the fourth quarter in total was down year-over-year.

So that's the negative.

Now the positive is that the November and December got sequentially better and by the time we got to December, we were -- on a community count-adjusted basis, we were showing positive comps year-over-year, and that has continued into January.

So that's part of the reason that I think we are slightly optimistic about what the spring selling season will hold.

I think in terms of kind of the affordability pinch that I highlighted in my prepared remarks, and I'd highlight it again here, I think that's been the challenge with buyers is, there has been an affordability pinch and then there has been a steady stream of kind of negative news, if you will, that plays out in the media and the newspapers almost every single day about the real estate market and that ultimately, I think, factors into the psyche of a buyer when they're getting ready to make a major life purchase like buying a home, some -- north of $400,000.

So if interest rates can maintain some stability, I think that's certainly a factor.

We need to continue to see some wage growth and I think the rate of price appreciation needs to moderate just a tad to not further exacerbate the affordability crisis.

So some things as far as big picture and I was kidding a little bit with my initial commentary about things that we're looking at into the future and that could change it for the positive or the negative, but in a big picture, we're always looking at consumer confidence.

That's something that I think is a big deal, and I highlighted that just a second ago with the buyer psyche.

So what's going on with the job picture, job adds, et cetera, on a market-by-market basis.

Certainly, we pay attention to traffic trends and then deterioration or improvement in overall sales volume.

And then any kind of quick or unexpected rate hikes would certainly also be the other kind of big picture factor that we would look to over the coming months that could significantly improve or erode how we feel about the spring selling season.

We will take our next question from Ken Zener with KeyBanc Capital Markets.

Ryan, last quarter, I asked you about kind of your view about existing inventory.

I know we're talking about price and affordability and interest rates, but I would just want to ask you again, I mean, do you think the existing inventory is tight?

And I ask because it would seem to potentially impact your trade-up buyers, which are, obviously, a lot of your buyers.

Could you talk about how -- or what you're seeing out there?

Yes, broadly, I would tell you that inventory levels are in the what I'd consider the healthy zone.

We always -- we have always pegged it at 6 months' supply and most markets are still running well below that.

There are still a few markets that are less than 3 months of supply.

So I would tell you, Ken, there is not a lot that's changed in the last quarter with the existing inventory supply.

Okay.

And then given your comments around SG&A in 1Q, I know you gave us a percent, but just looking back on '18.

Is there a fixed dollar value that we should think about for SG&A?

I apologize if I haven't modeled your commissions or your variable costs right.

I'm just trying to see how much that's going to swing around by quarter based on volume?

So...

Yes, I don't know that -- Ken, I don't know if there is a sort of a fixed dollar level you should think about.

Our commissions generally run around 3.5%.

And I think everything else is variable in the medium term.

So we feel pretty good about the SG&A that we delivered this year.

We highlighted that we were a little bit outside of our guide for the fourth quarter, but certainly well within or actually better than our guide for the full year.

We had a good year, so there was some compensation in the fourth quarter.

We highlighted the commissions.

So I think we'll -- it will be determined candidly by volume, right?

And so where the volume lands is what has it.

We think we've got pretty good controls over our expenses right now, and certainly, if there are places where we see the business not materializing to the level that we think it should be, we would look at costs there.

So -- again, it's not a fixed versus variable, because, candidly, everything is variable in the medium term for us and we feel pretty good about what we delivered in '18 and would expect to maintain that same level of discipline in '19.

We'll take our next question from Nishu Sood with Deutsche Bank.

So appreciate all the commentary about traffics -- traffic.

Wanted to ask about orders.

Bob, I think you mentioned December orders were higher than they were in November, which I think seasonally is atypical.

If we looked at it on a year-over-year basis, did that also register an improvement in the year-over-year order pace?

And then how have orders looked?

Are they better or worse in January?

Well, we haven't provided any commentary on January.

I don't have it in front of me as to December versus December, and we have to look at communities issue, but we can get that for you.

Okay.

And second question, the demand weakness that you mentioned across all buyer groups, I think, is how you characterized it.

That -- the kind of prevailing view out there is that the weakness has been mainly at the move-up and much less so at the first-time buyer.

Just wanted to understand your different take on the market, if we can look at it that way?

Perhaps one thought that occurs to me is that your first-time buyer category is at a price point of $375,000, which would be move-up for a lot of buyers.

Is that the difference?

Can you just help us understand your perspective about the demand trends across the buyer groups, please?

Yes, Nishu, our first-time, to your point, does include some higher price point communities, and it's mostly been driven by Northern California and Seattle.

We've got some truly first-time communities there that are price points that are north of $700,000.

So that somewhat influences that.

If you were to carve that out, we do still tend to run at the higher end of the first time price point spectrum.

And we've seen a softening, if you will, in those -- with those buyers just like we have with the move-ups.

We have seen nice strength in the active adult side.

This particular quarter, we are basically flat on an absorption level, but it is one buyer group that has held up quite nicely for us.

And Nishu, just to follow up.

December '18 versus December '17 was actually a little bit weaker.

It was actually off about 4%, but that was an improvement compared to October versus October and November versus November.

So that relative performance, and I'd highlight for you that the fourth quarter of last year was pretty strong.

We'll take our next question from Michael Rehaut with JPMorgan.

First question, I was just a little confused by a comment earlier around sales on a same-community basis, which sounds like sales pace or sales per community.

Did I hear right that December was up year-over-year in sales pace?

It doesn't seem that way particularly if orders are down -- were down in the quarter.

I just wanted to kind of understand how sales pace progressed throughout the quarter on a year-over-year basis month-to-month, and if I did hear right or you did mean to say that, that sales pace was up year-over-year in December?

Yes, Mike, I think it's the same question that we just answered for Nishu.

We actually saw absorptions down year-over-year but improving through the quarter.

Okay, so the down 4%, was that -- I thought that was just orders not sales per community?

That is correct.

Sales per community would be down also because community count was up.

And Mike, I think the comment that you're referring to that Bob made in his prepared remarks, on an absolute basis, we sold more homes in December in 2018 than we did in November of 2018.

We were simply trying to make the point that the market improved for us based on our current book as we moved into the back half of the year.

Or the back half -- back end of the year, back end of the fourth quarter, sequentially through the quarter.

Sequentially through the quarter.

Okay.

No, it's helpful.

I guess, just secondly, when you kind of think more broadly in terms of where we are right now.

I mean obviously, a lot of builders expressing kind of holding off of guidance and the spring selling season, as you've mentioned before, Ryan, kind of a bigger variable or question mark this year going in than several previous years.

How are you seeing it from the incentive side on a broader-market basis?

We heard from Horton late last week that there was a big move in incentives that they put into the market in November and perhaps that helped them reestablish pace, but obviously, at significantly lower margins.

I was curious about when you kind of did the step-up in incentives for -- during your 4Q, if that helped perhaps stabilize pace.

I mean, I guess it's still down year-over-year for you guys in December.

But -- I guess it's a -- really a two-parter.

Number one, when did you step up in incentives during 4Q?

And at this point, if sales pace continues where it is, do you need a further step-up to at least get that sales pace to be on the positive side?

Yes, Mike, there was a lot in there.

I'll do my best to, I think, at least in spirit to talk to some of the things that I think you're asking and I'd summarize by what I'm hearing you ask is, are incentives effective at increasing sales pace?

And I would tell you it has been or we wouldn't do it.

And -- our pricing model is such that on a real-time basis, we're evaluating every single community on a community-by-community basis, as we've talked about, and we're putting in incentives where we think they need to be.

We have made the decision not to do more than what we're currently doing because we run the kind of trade-off between how much incremental volume could we do relative to the increase in incentives and the math, frankly, just doesn't work.

So we like the way we're running the business.

We're running enough production through the machine for us to keep our trades and our pricing where it is, and we'll continue to look at the business the way that I think we always have.

And if things change, we'll react to that both to the positive and to the negative.

So that's probably the best I can do in terms of sum it up for you in terms of incentives and how we look at it.

We'll take our next question from Jack Micenko with SIG.

First question for Bob.

Help us understand where some of the financing incentives, buydowns and rate locks, where does that go on the income statement?

Is that going be seen in margin, G&A or in the financial service line item?

In gross margin, Jack.

Okay, great.

And then 77% capture rate.

You've got a good insight into most of your customers.

When you look at the mortgage data in the last quarter or 2, is it a DTI issue or is it an incentive issue?

What do I mean by that is, are we bumping against DTI caps?

Is there room to afford more and we just are comfortable our we're reading the news or whatever it is?

Or is the math just getting harder to work?

Are you looking at that from our perspective or the consumer, Jack?

(technical difficulty) off in entry level.

Can you hear me?

Yes, sorry.

I think, from the consumer standpoint, certainly, affordability has gotten challenged and the QM rules and the DTI limitations really do apply and so -- especially if you're at those lower price points.

I think that's where you're going.

It's getting more challenging for them.

It's interesting, though.

I mean, you look at our data and our average FICO this quarter was 752 again.

So there's qualified buyers out there.

And I think everybody is now lending against the edges of the qualified mortgage rules.

And so what we're seeing is actually a very, very competitive market, and so I don't know that -- it's certainly not credit availability that is an issue, and so for the consumer, it's just what can they afford to pay.

Yes, Jack, the one thing that I would tell you is we saw a little bit of a tick-up in the use of arms in the quarter, which I think would speak to the overall affordability pinch that we've been talking about as consumers are looking for ways to make the available dollars stretch a little bit further to cover the payment.

But I agree with Bob.

The LTVs that we see out of the mortgage company, that's been stable and really hasn't changed at all.

The FICO scores have been over 750 forever.

So it's a qualified group and while I generally agree that we're probably getting closer to the edges on what consumers can actually afford within the credit box or underwriting, I think it's as much as anything mentally buyers have decided they don't want to afford based on the negative headlines and some of the other things that we're seeing in play out in the overall economy.

We'll take our next question from Stephen East with Wells Fargo.

If we -- if you look at your cash, $1.1 billion, a big number.

A couple of things there.

One, what level are you all comfortable running at?

I assume it's significantly lower than that.

And if you look at your excess cash after investing in your business, what would be, as you look through '19, your first priority, second priority?

And thinking about buybacks.

I mean you can buy back a very large percentage of your shares outstanding if you decide to do that, but I don't know how M&A works into that, any debt repurchase, et cetera?

Yes, Stephen, maybe I'll just -- at a high level and then I'll let Bob maybe just chime in on the back end.

We're -- in terms of capital allocation and where we're going, we are not changing on that at all.

Number one priority is to invest into the business and I think you've heard us talk about that over time.

M&As including for us anyway as an investment into our business.

We see that the same as organic investment into a land pipeline.

We're paying our dividend.

You saw at the end of -- the end of the year, we increased our dividend for 2019, we announced that middle of December last year.

And then third priority is that we'll take excess capital that we don't invest in the business and we'll use that to buy shares.

So the overall focus of how we're using cash and allocating capital, no changes there; and then I'll let Bob speak to some of the cash questions that you have.

Yes, well, certainly, Stephen, we are pleased with the cash generation.

We actually exceeded our expectations this year with $1.4 billion of cash flow.

It has put us in a position of having a pretty significant cash position, and we're comfortable with that, to be perfectly honest with you.

Certainly, as Ryan laid out, our capital approach hasn't changed.

I think the only thing I would add to what Ryan talked about is we would think about leverage as part of that, we've talked that before, in terms of the near-term maturities.

We don't have any maturity stack until '21.

So I would tell you that we also think that given the volatility of the existing markets that having some cash on the balance sheet to be opportunistic wouldn't be a bad idea.

And so as we sit here today, we will do exactly as Ryan laid out, we'll think about leverage.

But if there is some dislocation in the market, we think we can be opportunistic.

We haven't seen the land values change much, but if they did, we'd want to be thinking about that as we look at what we're going to do investing in the business, as Ryan said, that's our first priority.

We'll take a question from Susan Maklari will Crédit Suisse.

My first question is just around some of the costs that you are seeing, some of the pressures there.

I know that lumber should be sort of a tailwind as we get to the second half of the year.

But can you talk to maybe what you're seeing in terms of the labor side?

Did that improve any, or have you seen any changes especially maybe with some of the uncertainty in the market?

Yes, Susan, I think we didn't highlight it but we see a relatively benign, on a relative basis to prior year, cost environment.

Certainly, lumber what we're flowing through the income statement today is a little bit high because it reflects the spike in pricing last year.

But to your point, we think that will be a benefit.

Outside of that and -- or I guess even including that, our expectation is probably for input cost labor materials, probably about a 2% increase in '19 versus '18.

And labor, I think the way we would characterize it is not getting worse.

We certainly -- as the market has gotten a little bit choppier, we've been out talking to our trades about opportunities for us to be more efficient to help them to be more cost effective for us.

That's going to be market by market depending on how much activity is going on, what the trade capacity is.

But I would tell you we see that as being less impactful in terms of an increase in '19 than we have for the last couple of years.

Okay.

And then my next question is just as we think about some of the regional trends that you talked to, not just for the fourth quarter, but even sort of for more broadly 2018, they are somewhat reflective of sort of these broader kind of population shifts and some of the bigger sort of trends that we've been seeing.

How do you think about your geographic footprint over the long term?

Is there anything that we should expect might change just over the course of time?

Yes, Susan, I wouldn't suggest that there's anything major coming in terms of our geographic focus.

We've long been the most graphically diverse builder, and I think that you'll continue to see us play in most major markets.

Certainly, the Southern states, Southwest and Southeast and Texas are places where migratory patterns would suggest that there is a high propensity of new jobs being created there as well as consumers and buyers relocating there, whether it's for jobs or quality of life or both.

I think you'll continue to see us make investments in those places.

That being said, we still have a business in the Northeast that we like.

This last quarter was a bit tougher.

Similar commentary around the Midwest.

So we'll continue to look to see where population growth is occurring and where jobs are being created.

Those are certainly 2 of the big drivers of housing demand and we would want to be positioned in such a way that we take advantage of it.

We'll take a follow-up question from Stephen East with Wells Fargo.

If we look at our land -- if we look at the vintage of land, your Del Webb are big communities, fairly old.

I'm trying to understand your business mix.

What type of vintage are you running through Del Webb right now?

And then as you reactivate the Centex brand, are you also -- is that primarily new land purchases?

Or are those more legacy purchases from years ago?

Yes, Stephen, I'll answer the second question first, which is these are new land purchases.

We do not have any significant dated assets that we are reenergizing or opening today.

And then with respect to Del Webb, we have 5 or 6 of the big communities, the same ones we've had for years, and we'll have for years coming.

Other than that, that book is turning over, on average, every 4 to 5 years.

The underwriting for most of the people we're doing now is somewhere in that 4- to 5-year range.

So we're cycling through those communities there a little bit longer that are nonage restricted but not much.

At this time, I'd like to turn the call back over to Jim Zeumer for any additional or closing remarks.

Great.

Sorry that we've run out of time, but we will certainly be available if you've got any questions over the course of the day.

We'll look forward to speaking with you later on, and otherwise, we will talk to you on our next earnings call.

Thank you for your time.

Ladies and gentlemen, this concludes today's call, and we thank you for participation.

You may now disconnect.