普爾特房屋 (PHM) 2019 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the Q4 2019 PulteGroup, Inc.

Earnings Conference Call.

(Operator Instructions)

I'd now like to hand the conference over to your speaker today, Jim Zeumer.

Please go ahead, sir.

Okay.

Thank you, James, and good morning.

I want to welcome participants to this morning's call to discuss PulteGroup's outstanding fourth quarter 2019 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 VP of Finance.

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

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

I want to highlight that we will be discussing our reported results today as well as results adjusted to exclude the impact of certain significant items.

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

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

Before I turn the call over to Ryan, I 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.

As detailed in this morning's press release, PulteGroup's fourth quarter results closed out 2019 on a high note, which I believe positions the company for even greater successes in the year ahead.

Our outstanding Q4 results reflect the strength of our overall market positions and homebuilding operations in combination with an ongoing acceleration and fundamental housing demand.

What I view as particularly encouraging is the broad-based strength of the housing market, as our Q4 order rates were higher across each of our geographic areas and across each of the buyer groups we serve.

Reflective of this strength in demand, traffic to our stores was up 14% over the prior year, while order rates increased 33%.

Housing continues to benefit from favorable market dynamics, including strong employment, consumer confidence and demographic numbers, which have underpinned demand for the last several years.

I think improved affordability across many markets is now adding incremental support and allowing more consumers to get actively engaged in the home-buying process.

While the slow start to 2019 resulted in our full year closings and revenues being up only slightly over last year, we still delivered increased earnings per share, generated $1.1 billion in operating cash flow, and that's after having invested $3 billion into the business, and we also returned almost $400 million to shareholders through dividends and share repurchases.

We were also successful in strengthening our financial position, having retired $274 million of our bonds that were scheduled to mature in 2021, with this helping us to enter the new year with a net debt to cap of only 21.7%.

Couple all of this with our highest-ending backlog in over a decade, and I think it's clear that we are extremely well positioned to grow the business and deliver even greater financial results in 2020.

While I am excited to speak with you this morning about this morning's announced acquisition of Innovative Construction Group, I'm first going to turn the call over to Bob, so he can finish reviewing our financial results.

Bob?

Thank you, and good morning, everyone.

PulteGroup's order volume and absorption rate were the highest we have generated in the fourth quarter in more than a decade.

For the period, net new orders totaled 5,691 homes, which is an increase of 33% over the prior year.

As Ryan indicated, we experienced strong demand across all geographies and buyer groups.

For the quarter, our first-time buyer orders increased 57% to 1,743 homes.

Move-up orders increased 27% to 2,471 homes, while active adult orders increased 22% to 1,477 homes.

In the quarter, we operated from an average of 865 communities, which is an increase of 5% over the prior year community count of 825.

Adjusting for community count, absorption pace was up 27% over last year.

Consistent with our orders, we realized higher absorption rates across our entire portfolio as absorptions increased 38% among first-time buyers, 29% among move-up buyers and 10% among active adult buyers.

The improved operating environment contributed to the company's strong financial performance in the quarter as home sale revenues increased to $2.9 billion.

Higher revenues in the period were driven by a 2% increase in closings to 6,822 homes as our average sales price was down less than 1% to $429,000.

Our average sale price for the period reflects a combination of pricing dynamics and mix shifts realized in the period.

More specifically, our average sales price for move-up and active adult closings increased 4% to $494,000 and $423,000, respectively, while pricing for first-time homes decreased by 8% to $342,000.

It's worth noting that the decrease in first-time ASP reflects the ongoing and purposeful expansion of our entry-level business, particularly in the Southeast, Florida and Texas.

This successful expansion of our first-time business is also demonstrated in the mix of our fourth quarter closings.

By buyer group, closings in the quarter were comprised of 32% first time, 45% move-up and 23% active adult as compared with 26% first time, 47% move-up and 27% active adult in the fourth quarter last year.

These results include the closing of 432 more first-time homes this quarter than the fourth quarter last year.

Given the increased investment we have been making in assets that serve this buyer group, we believe we are well positioned to continue expanding this element of our business.

The strong order environment has also contributed to a 20% increase in our backlog over the same period last year to 10,507 homes.

As a result, we've been increasing our production such that we had 10,780 homes under construction at the end of the quarter, which is up 14% over last year.

Of the homes under production, 69% are sold, while the remaining 31% are spec.

On a percentage basis, spec production is down from last year, but up sequentially.

This largely reflects the introduction of incremental spec units in our entry-level communities as we seek production efficiencies and to meet the move-in ready expectations of that buyer group.

Given the homes we have under contract and production, we expect first quarter deliveries to be in the range of 5,300 to 5,500 homes.

At the midpoint, this would represent an increase of 17% over the first quarter of 2019.

With this strong start to the year, we expect full year deliveries to be in the range of 25,500 to 26,250 homes in 2020.

Based on the relative strength of our first-time communities, we expect the average sales price of closings in the first quarter will be in the range of $410,000 to $415,000, with full year ASP in the range of $415,000 to $420,000.

Continuing down the income statement, our reported gross margin in the fourth quarter was 22.8% compared with prior year reported an adjusted gross margin of 21.5% and 23.8%, respectively.

Our gross margin for the quarter came in lower than our previous guidance due to a number of factors.

Notably, we delivered more homes than we expected in California, where pricing was under pressure much of the year.

In addition, we realized higher-than-expected warranty costs at a limited number of previously closed communities, and we recorded a couple of minor inventory impairments.

While none of these items were individually significant, together they did act as a margin drag in the period.

Demonstrating the real ongoing strength of our business, we expect our first quarter gross margin to increase sequentially and to be in the range of 23.0% to 23.3%.

In fact, the potential is there for margins to improve further as the year progresses, and we currently expect full year gross margins to be in the range of 23.0% to 23.4%.

Our reported fourth quarter SG&A expense of $262 million or 8.9% of home sale revenues, included a $31 million pretax benefit from an insurance reserve adjustment recorded in the period.

Excluding this benefit, our adjusted SG&A expense was $293 million or 10% of home sale revenues.

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

With expectations for higher closing volumes in 2020, we believe we can realize incremental overhead leverage.

As such, we expect SG&A expense for 2020 to be in the range of 10.5% and 10.9% of home sale revenues.

Our financial services operations generated fourth quarter pretax income of $34 million compared with $5 million in the fourth quarter of last year.

Last year's results included a charge of $16 million for a reserve adjustment recorded in the period.

This year's improved financial performance also benefited from a strong margin environment, higher loan volumes resulting from growth in our homebuilding operations as well as a higher capture rate.

In fact, our mortgage capture rate increased to 84% from 77% last year.

In the fourth quarter, our income tax expense was $100 million for an effective tax rate of 23% compared with $92 million for an effective tax rate of 27.9% last year.

Our fourth quarter rate was lower than our previous guide as we benefited from an adjustment in valuation allowance associated with certain deferred tax assets as well as the benefit related to the recent approval of the energy tax credit.

Looking ahead for 2020, we expect our base effective tax rate to be approximately 25%.

In total, our reported net income was $336 million or $1.22 per share in the quarter.

On an adjusted basis, our net income for the quarter was $312 million or $1.14 per share.

In the prior year, our reported net income in the fourth quarter was $238 million or $0.84 per share, while adjusted net income was $314 million or $1.11 per share.

Our fourth quarter diluted EPS was calculated using approximately 271 million shares, which is down 9 million shares, were roughly 3% from the fourth quarter of last year.

Our lower share count is due primarily to our ongoing share repurchase activities.

During the fourth quarter, we invested $771 million in land acquisition and development spend, bringing our total land spend for 2019 to $3 billion.

We ended the year with approximately 158,000 lots under control, with 41% of them held via option looking to 2020, we expect our total land spend to increase to approximately $3.2 billion.

Given our existing land pipeline, we expect full year 2020 community count growth of 1% to 3% over 2019.

Growth will be closer to 3% to 5% in the first quarter of the year, reflecting the benefit of last year's American West acquisition.

In the fourth quarter, we repurchased approximately 765,000 common shares for $30 million for an average price of $39.16 per share.

For the full year, we repurchased 8.4 million shares for $274 million or an average price of $32.52 per share.

After all this activity, we ended 2019 with $1.2 billion of cash, and as Ryan mentioned, a net debt-to-capital ratio of 21.7%.

On a gross basis, our debt-to-capital ratio was 33.6%, which is down 500 basis points from last year.

Let me now turn the call back to Ryan for some additional comments.

Ryan?

Thanks, Bob.

Consistent with the 33% increase in orders, the demand environment in the fourth quarter was obviously much stronger than last year.

We saw generally strong demand in the eastern third of the country with Florida continuing to deliver exceptional performance.

Demand in our Midwest and Texas operations was also much improved with our Texas business, in particular, benefiting from increased business among first-time buyers.

Demand in west was certainly much stronger in the quarter, and I would cautiously highlight that Northern California appears to be finding its footing after a tough 12-plus months.

Strong fourth quarter demand, which has continued into the first few weeks of January has us heading into 2020 with much higher expectations than we had at this time last year.

We are optimistic that a good macroeconomic backdrop and better affordability should keep buyer interest high in the year ahead.

Now with the review of our operating and financial results complete, I want to discuss PulteGroup's acquisition of Innovative Construction Group or ICG.

For several years, you've heard the construction industry talk about a tight labor market and how this is adding to our construction costs and cycle times.

Given these conditions, you've also heard us discuss efforts to expand the use of off-site manufacturing in our construction operations.

As you know, we launched our commonly managed plan platform in 2011 to better standardize our product offering and simplify our purchasing and construction processes.

In 2019, 81% of our closings were from our common plan portfolio.

With the success of this platform, we have viewed capturing the benefits of off-site manufacturing as a next logical step.

Over the last 18 months, we've met with numerous businesses that are working to bring increased automation to homebuilding.

It is through this work that we identified ICG, which provides framing solutions to residential and commercial contractors in and around the Jacksonville market.

ICG's off-site solution includes offering design services, manufacturing wall panels, roof trusses and floor systems and on-site installation to provide a full-frame shell construction process.

In evaluating ICG, we were very impressed by the management team along with the product quality, production efficiency and overall innovation of the plant's operations.

Working closely with the company founders, who will continue to lead ICG going forward, we plan to extend the use of preassembled floor systems and to expand the factory's production capabilities to include installed windows and wall prep for mechanical, electrical and plumbing.

ICG will remain a stand-alone operation and continue serving its existing customer base and builder clients.

This acquisition has the potential to benefit our Jacksonville operations through faster cycle times, precision structural components and savings on lumber and other materials.

More importantly, we see this facility as a model for integrating increased off-site production in other PulteGroup divisions.

While likely a few years down the road, the opportunity is there to develop comparable production plants in areas where our scale and adjacent markets can support a dedicated factory.

It is important to note that ICG is just one component of our strategy as we do continue to partner with key suppliers to move more of our production into a factory setting.

This is one plant serving one market, but we're greatly encouraged by the potential off-site production offers to enhance our operations in North Florida today and other markets in the future.

We see the opportunity to produce high-quality components with greater efficiency, while allowing PulteGroup to work more effectively with its trade partners.

We look forward to providing updates on this venture and related activities as they develop.

Before opening the call to questions, I want to welcome the employees of ICG into the PulteGroup family and thank our entire team for their outstanding work in 2019.

Thanks to your efforts, the company is operationally and financially strong, and we head into 2020 with tremendous momentum.

Now let me turn the call back to Jim Zeumer.

Great.

Thanks, Ryan.

We'll now open the call for questions so that we can speak to as many participants as possible during the remaining time in this call.

We ask that you limit yourself to one question and one follow-up.

(Operator Instructions) And our first question comes from the line of Michael Rehaut with JPMorgan.

The first question I had was just on the drivers of the gross margin for 2020 and expecting a little bit of improvement.

I was hoping you could break down how you're thinking about the different components of that -- those drivers by either mix, pricing, cost inflation, what are the bigger drivers there?

Yes, Mike, it's Bob.

Obviously, when we look at the business and how we want to project our margins going forward, the first start we place -- the first place we start is our backlog.

We've got a strong backlog coming through the year.

So we know the pricing embedded in that.

We think about how the business has performed largely over the last 3 months as we've built that backlog.

And so as an example, California, we've seen pricing get a little bit firmer out there.

We've seen a little bit more volume.

And -- but -- so I guess, as simply as I could say, it's based on what we see in our backlog.

We're not assuming price appreciation.

I can tell you that as we look at vertical construction cost in fiscal '20, we see about a 1% increase, so relatively modest inflation.

Lot costs are obviously going to get a little more expensive as we move more recent into surface of the portfolio.

But again, that's all factored in.

But we're not assuming price appreciation in that guide.

Okay.

Appreciate it.

I guess for my second question, I was -- and I apologize, I was pulled away for a moment during some of the prepared remarks.

The ICG acquisition, I was curious about that in terms of the rationale.

And again, I apologize if you kind of addressed this already.

But just the rationale behind buying the company outright versus being a customer as is and reaping the benefits of the efficiencies of the business or the business relationship as a -- simply as a customer or perhaps making an equity investment to allow the company to grow further without fully consolidating it and kind of adding an additional cost structure, so to speak, on to your own book?

Mike, it's Ryan, and good morning.

Thanks for the question.

I think as we looked at -- the way I'd explain that as we looked at ICG, I think there are a number of different ways that we potentially could have reaped some of the benefits associated with the off-site manufacturing.

You highlighted a number of those.

We elected to go the route that we did for a number of reasons, which I probably won't get into on this call.

What I will tell you is, the path that we've chosen to take on this particular acquisition was right for this particular opportunity.

We're going to, as we look at our entire operation across the country, continue to leverage relationships with other suppliers, where we're looking to move as much of our production into automated-type factory settings as we can.

And in many of those cases, it will be with existing suppliers that are bringing technology to the table.

We are going to use the learnings from this plant to certainly enhance right away our Jacksonville operations, and we'll use those learnings down the road to potentially look at standing up new plants of our own where we have the right amount of volume to support those.

So we're really excited about what this does.

It's been a journey, frankly, in the making since 2011 when we started our commonly managed planned portfolio, and this is the next logical step.

So more to come, but suffice it to say, we're pretty excited about what this opportunity holds for the industry.

And our next question comes from the line of Stephen Kim with Evercore ISI.

Let me follow-on Mike's question here on ICG.

A number of questions, maybe you can just sort of take them all as one.

I'm curious about your longer-term plans, this opportunity to expand.

Are you thinking that it's going to be more along the lines of these integrated systems with the mechanicals, integrated and windows?

Or would be more kind of like the raw -- their skeleton as you think about the opportunities?

And can you give us a sense for the -- an estimate of how much you think that you're saving or they are saving in the Jacksonville market?

And whether you think that, that's something which can increase as you take this across the country?

Yes, Steve, I'll take the first question as far as where we see this going in the future.

And I think it's really the latter or the first piece that you mentioned, which is to take it to the level of plumbing, electrical, window installation, et cetera.

So I think even an advanced level of manufacturing from what's readily available, I think, in most markets today with just the raw frame shell.

So ICG is already starting to do some floor cassettes, which we think is kind of in that more advanced level off-site manufacturing.

And as we look to this existing operation plus the places down the road, we think the real opportunity is to get into the more advanced manufacturing.

We're certainly going to get benefits today from kind of the frame shell components of walls and trusses, but where we really see the benefit coming as in those more advanced manufacturing techniques.

In terms of kind of the benefit, Stephen, we certainly believe that there's benefit there.

I would highlight for you that this is a kind of single plant in a single market.

So any impact in our overall reported results, I think, will be modest.

But it's a big step for the company and a journey that we're really excited to take over the next 2 or 3 years.

Excellent.

Well, I know you guys have done a tremendous amount of work there.

So it's maybe probably one of the best positions to know.

Second question relates to the entry-level segment of the market.

We highlighted this morning that there were some changes done with respect to housing policy or at least changes that look like they're coming, which could be helpful to the lower end of the market, even beyond what we've seen over the last couple of years.

I'm curious as to whether or not you have seen any change in the entry-level of the market.

We know that there's been a lot of other folks moving into that segment of the market in a more serious way.

And I was curious whether or not you have continued to see strength at the entry level or if you've seen it start to moderate in any way.

So just your commentary about what you're seeing in the marketplace from a -- at the lower end of the market?

Yes, Stephen, it's Ryan.

I'll take the first piece of that.

We are seeing continued strength.

And I think it's evidenced in our reported numbers for the fourth quarter on our first time entry-level space.

We had 57% year-over-year sign up growth, which is pretty robust.

So we're excited about that.

We're excited about the continued investment that we've been making over really the last 2.5 years to meaningfully move the number of lots that we control that are specifically targeted to this first-time space.

And so I like how we're positioned there.

Some of the changes that you speak to, I think, have certainly helped with the overall affordability equation and providing attractive and accessible financing to even more buyers, and I think that is all factored into the overall demand situation that we're seeing from the first-time entry-level buyer.

And our next question comes from the line of Matthew Bouley with Barclays.

I wanted to ask about the move-up business.

Obviously, strong absorption growth there as well in the quarter.

And obviously, many of your competitors are leaning harder into the entry level.

So I guess, on move-up, how do you think about, at this point, Pulte's position competitively, both in terms of land acquisition and potentially even pricing power at move-up communities just because simply you don't quite hear as much about your competitors leaning into that part of the business as much?

Matt, it's a good question, and I think it highlights the reason or maybe gives me an opportunity to reiterate the balanced mix and the balanced approach that we have tried to take with our business.

And if I take you back to kind of late 2016, what we started talking about was an opportunity to shift about 5 points of our business out of move-up and into entry level, and you're starting to see the results in our closed home mix from that effort.

What that yields, just to give you some specific numbers.

In the fourth quarter, 43% of our sign-ups were from our move-up business.

So it continues to be the largest piece of our business.

It's a very profitable piece of our business, and it carries kind of our flagship brand of Pulte Homes.

So we like how we're positioned.

We have not abandoned it at all.

Rather, I think we've more appropriately shaped the size of that business to be reflective of the market opportunity.

We think we've also -- the counterbalance to that is that we think we've gotten better position to take advantage of the first-time opportunity as well.

Suffice it to say, we don't have all of our eggs in any one single basket, and we like that.

Okay.

I appreciate that color.

And then secondly, I wanted to ask on the SG&A side.

You're guiding to relatively flat leverage in 2020, maybe slight leverage at the midpoint, but obviously, you are set up well from a backlog standpoint around revenue growth.

I guess just there -- are there any other expenses, there were some of the IT spending you were talking about last quarter that we should be aware of that might prevent some of the kind of additional SG&A leverage?

Yes, Matt, it's Bob.

We -- obviously, when you adjust for the current year, we come in around 10.8%.

So the range that we've given shows some -- even at the midpoint, some improvement over that.

Certainly, we've talked about over the last couple of years that we've been on a journey on the IT side, upgrades of our systems.

As those systems get put in place, we're actually starting to depreciate them now.

So we've got some costs associated with that.

So really nothing new or unusual in that.

It's really just being able to leverage the increased scale of the business.

And our next question comes from the line of Mike Dahl from RBC Capital Markets.

I first wanted to start with a question around kind of pricing, power and the momentum in gross margins.

I think, Bob, you talked about the potential for margins to improve as the year goes on.

I'm not sure if that was still within the construct of the full year guidance that you're giving or suggesting that there could be upside from there.

But as a starting point, could you talk about just the pricing power that you've seen, maybe if you can give kind of percentage of communities that you've been able to raise price?

Any sense of magnitude and how that compares year-on-year over the past few months?

Yes, Mike, just to clarify, that improvement was included in the guide, not outside the guide.

So that's just reflecting that the range for the year actually goes a little bit higher than what we prepared for the first quarter.

In terms of pricing power, I think if you look at our ASP, during the quarter, it's roughly flat on an aggregate basis, but you've actually got a decrease in the entry level, which is really a reflection of the types of assets we're providing there.

There's actually -- if there's any pricing -- real pricing power in the market, I think it's there.

And I think it has been for probably the last year or 2. We showed about 4% up on the move-up and active adult.

So I think there isn't a real substantive change in the product we're delivering.

So I think that gives you some insight into what the pricing power is around that.

Mix always matters where -- what markets it comes from all that.

But on balance, I would say you've got more power to price in the entry level, although they are price-sensitive.

So there's a limit to how far you can push that but we're seeing prices hold and go up a little bit in the balance of the business.

Yes.

And Mike, the only other thing that I'd add to that is, I think with the strength that you're seeing on the volume side and we're starting to see some reduced inventory levels, I think, certainly, that would create an environment where all of the builders will have more pricing power.

The thing that, I think, you'll see certainly us and all builders be cautious with is the affordability equation.

We all saw what happened kind of in the back half of '18 when affordability became challenged.

And so pricing is one of the key levers in that mix, and I think we want to pay attention to that.

Okay.

And the second question, just another follow-up on ICG.

And Ryan, I appreciate that there are some things that you don't want to get into in terms of the details.

But I did want to press again on just -- since you'll continue to have ICG serve its external customer base, what is the true differentiation to Pulte of owning the assets?

Is it just the firsthand learnings you've discussed?

Or was this may be more of a situation where you were an existing customer?

And had you not taken this position, you could have lost access to them as a supplier or any other dynamic at play that could just kind of explain why this ends up being differentiating for you versus as others have questioned, just having this be more of a partnership, but still a traditional kind of customer relationship.

Yes.

I think the opportunity here, Mike, is really twofold.

Number one, we see it as a great opportunity to partner with the founders to speed up the innovation moving from the current version of frame shell into some of the more advanced manufacturing techniques.

So that's something that we've been talking about.

You've heard us talk about really for the last 2-or-so years that we think there's a tremendous opportunity there.

And then the other piece is, with 80% of our closings coming out of our commonly managed plan portfolio, we see this opportunity really applying to other parts of our business besides just what it's going to provide in the North Florida market.

So that's something that we think working with the founders of ICG, we can really benefit from other parts of the country.

The biggest reason, Mike, and I can't overemphasize this enough, this is about labor.

We have been talking about labor shortages in this industry for the last 10 years, give or take, there doesn't seem to be anything that's going to structurally change the availability of labor.

And so the only logical off ramp that we see to that is getting more efficient.

And one of the avenues that we think is the easiest or the most easily accessible off ramp is to truly having a housing operation that can benefit from off-site production.

And we see the unlock that it gives us on the tight labor supply as a huge benefit.

And your next question comes from the line of John Lovallo from Bank of America.

The first one on ICG.

And I think this is an incredible opportunity.

And frankly, we see it as the future of homebuilding.

So I think this is an excellent move on your part.

But ICG looks like they have the ability to deliver a complete, fully integrated off-site solution.

I mean building information modeling, component manufacturing, installations, et cetera.

And it looks like that you're taking kind of more of a piecemeal approach here just to start with some more prefab parts, and so instead of going for the full solution.

So I guess the question is, is this just being a little bit conservative on the onset here?

And how quickly could you kind of pivot in the Jacksonville market to really deliver a fully integrated off-site solution?

John, it's Ryan.

We haven't given that level of detail yet.

But I think what you highlight is what the real opportunity is, and that's certainly what we're focused on.

The -- as I mentioned in some of my prepared remarks, the level of innovation that was existing inside of ICG is one of the things that made it really attractive.

So to your point, they have design services.

We're manufacturing precision components.

We've got the ability to assemble those precision components with the on-site labor.

And so the next logical step is some incremental investment and then to kind of systematize in a way that you can do it in a volume-type setting.

And so that's what the opportunity is and certainly what we're squarely focused on.

Okay.

That's helpful.

And then maybe just more of a housekeeping item here.

The gross margin in the quarter, I think you guys had highlighted California incentives, warranty and inventory impairments.

Any way you can kind of bucket the impact in the quarter from each of those?

Yes, I wouldn't because none of them are individually significant.

If they were, we would have walked you through them.

Yes, I would characterize the total of it is being somewhere in the neighborhood of 40 basis points of margin impact on the quarter.

And our next question comes from the line of Alan Ratner with the Zelman & Associates.

Congrats on the acquisition.

My first one on ICG.

Just here in your comments about some of the things that were the future where you could see this going, and especially the closed panels with the windows and the plumbing and the electrical, et cetera, already pre-installed.

One thing that we typically hear from builders is the reason why perhaps that hasn't become more mainstream is the very high transportation costs associated with that, bringing those products to the job site as well as breakage.

I mean I know builders even back in the '80s and '90s were experimenting with that stuff, installing windows and things.

So is there anything that ICG has done that kind of has cracked the code to make that process more efficient and affordable from a building perspective that the math actually makes sense now?

Or is that just something that you think you've got the right team in place to pursue that, but perhaps they're not quite there yet?

Yes, Alan, thanks for the question.

I appreciate it.

As we mentioned today, what's coming out of ICG or the wall panels, the floor cassettes and manufactured trusses.

We think there's an opportunity to go to the closed wall panels, inclusive of windows, electrical, plumbing, et cetera.

Work and investment has got to be done on that.

I think you highlight the challenge that applies to all our site manufacturing, not just kind of the second stage and its transportation.

And so what that means is that you've got to have enough volume within a relatively close proximity such that the transportation costs don't offset the savings that you get from building those components in a more efficient way.

So work to be done, investment to be done to figure that out.

It has been done in other places, in other applications.

And so we think that the ability to do it is there.

And then I think the next logical question is, well, why is this time going to be different?

And it goes back to the question that I answered a few back, which is labor.

And we just don't see labor rates going in a direction that will challenge the efficiencies that are gained from the manufacturing environment, which has happened in the past.

But because of what I think is going to be a persistent shortage of labor, we really view this as a new opportunity to do something different.

Got it.

That's helpful, Ryan.

And second question, maybe for Bob.

Just kind of thinking about the capital allocation.

Thinking at this point here, your net debt to cap is at the lowest level we've seen in many years.

And at the same time, buybacks decelerated this quarter and then for the year were down fairly meaningfully from the prior few years.

So how are you thinking about the balance sheet, the capital allocation at this point?

Is there another kind of use of that cash that's being earmarked at this point?

Or is it a function of where the stock price is?

And any commentary you can give there.

Yes, it's going to sound a little bit redundant and boring, but it's kind of the same playbook we've been working from for the last several years.

We pulled every lever.

This year, we bought stock.

We increased our dividend.

We retired some debt.

We've invested in the business.

We've indicated we'll be investing more this year.

Obviously, we've got an investment we just made in ICG.

And I think you'll continue to see all of those things be in our windshield.

We obviously expect pretty strong cash generation in fiscal '20.

What we've highlighted and consistent with, I think is, we'll report the news on the share repurchase activity.

But I think any and all of those are still front of mind, but nothing new or different to report beyond that.

And our next question comes from the line of Jack Micenko with SIG.

First one, a little bit bigger picture for Ryan.

Thinking about this pivot towards the entry level, and it seems that's maybe occurring a little bit faster than maybe you'd expected the success or the uptick.

On the entry-level side, you've got a real game of competition.

You've got bare-bones product, you've got everything included on the other end, and then somewhere between you've got build-to-order.

I'm curious how you see Pulte really positioning and competing in entry level from a product standpoint as that business gets to be a bigger part of your mix.

Yes, Jack, I appreciate the question.

You're going to see us play on the higher end of the entry-level price point.

We have made some modifications to our typical build-to-order model, and you heard that in Bob's prepared comments that the -- we are building more specs in that business to kind of meet the demand that's there.

And so you saw a little bit of an uptick in our specs as a percentage of total inventory.

And it's largely reflective of more specs in that entry-level business.

We are limiting the choice within our Centex model to drive some of the efficiencies that we are, in turn, passing on to the consumer, which really creates the affordability and the value that this first-time buyer desires.

So less choice, less ability to customize, but you're getting a really nice home and a lot of home for the money.

And we think that's where the magic is.

We'll continue to deliver the great customer experience, the high quality, the quality location of community that I think all of our brands have been known for.

I don't think you'll see -- well, you won't see us probably go with the bare-bones model, the really small square-footage model.

We just don't think that's part of the offering that we give to the consumer.

Okay.

And then in that 5 points of pivot given the uptake that you've seen.

And I think last quarter, you said that the margins in the entry were healthy or perhaps than the move-up.

Does that 5-point number expand?

Are you leaving the door open for that to expand?

Or are you going to say, hey, look, we want to be a balanced business, and 1/3 of the book is all we really want on the entry side?

Yes, Jack, I think the over -- the key message that I'd emphasize is we want to balance business.

I think you'll see it maybe it may go down a few points, it may go up a few points as opportunities arise.

Our overall focus is going to continue to be to drive through cycle return on investment within the residential housing space.

And so as we see trends emerge, we'll certainly take opportunities where they present themselves.

But with the focus on being more balanced, I don't think you're going to see us place outsized bets in anticipation of some future trend.

So we're pretty close to probably where we want to be is probably the message that I'd leave with you.

And as far as margins go, to your other question, we like the margin profile that we're getting out of the entry-level space.

They're attractive margins, and it's really reflective of what Bob shared, which is that's the place where we've seen the ability to get some price expansion.

What I would emphasize, Jack, to the comment I made a minute ago about our focus is on return.

We really look at the underwriting of that business is the same as we look at move-up and the same as we look at active adult.

So certainly, gross margins are part of the story, but the real prize is return on invested capital, and we look at all of our consumer segments the same when it comes to return.

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

So your entry level a few years ago, people were so concerned around the Del Webb.

You seem to be putting that to rest.

My question is this, if you're moving in entry because that's where demand is, it makes sense, you're building more spec homes, why is that approach given your hesitancy to do it on in other categories, what is the risk-return that you're seeing there?

Is it because you're controlling more labor like some other builders have talked to?

Is it that -- what is it that gets you over that risk profile that you have for your other categories in short?

Yes, Ken, it's Ryan.

Risk is just part of it.

It's really about value in the eyes of the consumer.

And so as we've looked at what the consumer is willing to pay for, we believe that we're more efficient, more profitable and manage risk better with the move-up and active adult buyer, when they get the opportunity to choose the things that they value.

And that's part of our strategic pricing model that has contributed to the margin profile that we have today that we're very proud of.

We think with this entry-level consumer, they value different things, and affordability and access is probably the biggest driver.

And so by limiting the amount of choice that we give, building a few more specs, having those homes quicker to deliver because this buyer, in theory, is coming out of an apartment, they just operate on a little bit different buying cycle than our move-up in our active adult buyer.

And so it's less about risk and more about maximizing value and given the consumer the things that they want and need.

I understood.

I think it's a good move.

Second question, could you expand a little bit since you mentioned it, the gross margin drag in California.

Could you just talk about it being north, south, coastal, inland, et cetera, just to give us your perspective since that was something you called out specifically?

Yes, Ken, I think California as a whole, it's been no secret, has been a drag and has had -- it's been a tougher selling environment for really the last 12 months, south and north, coastal and inland.

In order of severity, I think Northern California Coastal probably being the hardest hit and the slowest.

It also happens to be the place where we're starting to see some strength start to come back into the market.

And so we're cautiously optimistic as we've got a very strong business or a nicely positioned business in Northern California and the Bay Area, in particular.

So probably the drag more on discounts and incentives that had to be -- that were given to continue to sell homes in Northern California over the last 12 months.

Our next question comes from the line of Truman Patterson with Wells Fargo.

First, just wanted to follow-up on the move-up market, get a little bit more color on that.

Our field research recently has revealed a healthy move-up market, which I'll just say has been ahead of our expectations, quite frankly.

But what do you really think is driving that?

Is it lower rates kind of breaking up the prior rate lock?

Are you starting to see the leading edge of the millennials purchase and earnest in the move-up market?

Really, what do you think is driving that improvement?

Yes.

I think like everything else, it is the health of the economy, first and foremost.

So you've got wage inflation, you have relatively slower price appreciation there.

Rate certainly helps if it's benefiting.

So all those things coupled together, one of the earlier questions talked about sort of the big move for a lot of the builders to the entry level, which has, to a degree, pinned out the competitive sets of supply, is in pretty good shape, both from a new build perspective.

And we've got a healthy supply in just about every market where we're operating today in terms of days on market for resale, which is our biggest competitor.

So I think all those things together have lent themselves to a pretty nice business for us, 29% absorption increase, 4% price appreciation is pretty nice.

So we like the business, I -- apparently what Ryan said earlier, it's the reason we're not making a big bet one way or the other, we think, through time, being able to serve in each of the markets where we operate, the set of consumers that are there.

And it's going to be different, for instance, in some parts of Florida than what it is in some parts of the Midwest, right?

So that we're looking at each market and investing to serve a balanced portfolio in the market where we're operating.

Okay.

Okay.

I absolutely agree with that.

On the cost inflation outlook for 2020.

I know you guys mentioned 1% stick and brick was likely to occur, what you were expecting.

Could you just break up your outlook for land, labor and materials?

And whether or not you think this accelerates versus 2019?

Yes.

It's interesting.

On the land side, it's a competitive market.

You've heard us say this before, it always is.

I think you'll see certain parts of the country and certain asset classes be more competitive than others.

But I think we're going to see continued land pressure.

We see it in the land coming through and closing today.

And I don't think land is on sale.

In terms of labor and materials.

On the material side, we've got a little bit of a tailwind in the first half of the year, reflective of the decreasing price of lumber and lumber package in the back half of last year, which will affect our closings now.

But we've seen lumber tick up a little bit, not bad, but a little bit.

So we think that will moderate through the year.

All the other real -- other than concrete, which is always local to a market, we see a pretty benign material inflation rate.

Labor is, as you've heard us talk about, and the reason for the ICG investment is always a little bit of a wildcard, it's been better the last 12 months.

And so our expectation is that we don't see a lot of pressure on labor rate, that's going to vary by market.

But obviously, we think about 1% up overall.

Once again, that's going to largely be labor just given the way the materials market is behaving.

And our next question comes from the line of Carl Reichardt with BTIG.

Jack and Truman got a couple of mines.

So I just have one for you.

With move-ups looking better, first-time mix has moved that way that the old cruise ship Del Webb stuff has kind of come off.

I'm curious what you're thinking about inventory turns next couple of 3 years, how important that metric is to you?

You turned about your inventory about one time a year by my numbers.

Are you expecting that to pick up meaningfully?

And how important is that metric to you all as a driver of return?

Yes, Carl.

Look, it's a big driver of return.

And so I think the way that we look at inventory turns is breaking down, what do you get on the house side?

And what do we get on the land side, with 80-some-odd percent of our balance sheet being inland, that's the lever that can really move the needle on overall inventory turns.

And it's a big reason why you've heard us talk about doing shorter-duration land deals with more options because it drives right at the heart of the inventory turn equation.

So the hope would be that we can continue to grow that.

As we roll in more options, as we roll off some of the cruise ship Del Webbs that you mentioned, we'd look for opportunity to accelerate our land inventory turn.

On the house side, that's a balance between really cycle time, how much labor is available and delivering a high-quality product.

And I think it's another reason why we've made the investment in ICG is because it speaks to all of those.

You've got an opportunity to build with more precise components that aren't sitting out in the rain and the snow.

You've got the ability of the BIM modeling and some of the technology that factors into that.

And we think we can cut cycle time as well.

So we think there's an opportunity to kind of pull all of the levers there with more efficient labor, higher-quality materials being more cost-efficient.

So we think there's a lot of goodness.

And ladies and gentlemen, that's all the questions -- time for questions that we have today.

So I'd like to turn the call back to Jim Zeumer for some closing remarks.

Great.

We appreciate everybody's time this morning.

We're certainly available over the remainder of the day though for any follow-up questions, and we look forward to speaking with you on our next call.

Ladies and gentlemen, this concludes today's conference.

You may now disconnect.