Jim Zeumer - VP, IR and Corporate Communications Ryan Marshall - President and CEO Bob O’Shaughnessy - EVP and CFO James Ossowski - VP, Finance and Controller.

Nishu Sood - Deutsche Bank John Lovallo - Bank of America Michael Rehaut - JP Morgan Bob Wetenhall - RBC Capital Markets Mike Dahl - Barclays Stephen Kim - Evercore ISI Stephen East - Wells Fargo Alan Ratner - Zelman & Associates Jack Micenko - SIG.

Good day and welcome to the Q4 2016 PulteGroup, Incorporated Quarterly Earnings 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, Eric and good morning. I want to welcome you to PulteGroup's conference call to discuss our fourth quarter financial results for the three months ended December 31, 2016.

Joining me here for today's call are Ryan Marshall, President and CEO; Bob O’Shaughnessy Executive Vice President and Chief Financial Officer; James Ossowski, Vice President, Finance and Controller.

A copy of this morning's earnings release and the presentation slides that accompanies today's calls have been posted to our corporate website at pultegroupinc.com. We'll also post an audio replay of today's call a little later today.

Before we begin the discussion, I want to alert all participants that today's presentation may include forward-looking statements about PulteGroup's future performance. Actual results could differ materially from those suggested by our comments made today.

The most significant risk factors that could affect future results are summarized as part of today's 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. With that said, now let me turn the call over to Ryan Marshall.

Ryan?.

Thanks Jim and good morning. I’m extremely pleased with you this morning about PulteGroup’s strong operating and financial results for the fourth quarter and full year 2016. At the outset of the housing recovery, we explained our focus on improving the company’s fundamental business performance and overall returns on invested capital.

As our business and financial metrics improved, we then discussed the opportunity to systematically increase our land investment, which we did beginning later in 2013. Then headed in to 2016, we talked about the year being an inflexion point for the company, as our increased land investment would begin delivering higher growth.

As our financial results indicate, 2016 was indeed that inflexion point as we realized a meaningful expansion of our business.

On a year-over-year basis, PulteGroup reported 13% growth in unit sign-ups to 20,326 homes, while closing volume increased 16% to just shy of 20,000 homes, benefiting from a 10% increase in ASP for the year, home sale revenues increased 29% to $7.5 billion and perhaps mostly importantly our reported earnings increased 29% to $1.75 per share.

While growth is important, it is worth highlighting that consistent with our focus on creating value for our shareholders, the significant growth in our business was achieved while continuing to deliver high returns on invested capital and equity.

Clearly 2016 was a year of exceptional performance and progress for the company, and has us well positioned for continued success in 2017 and beyond. While 2016 was an inflexion point in the growth trajectory and performance of our business. We expect 2017 to be another outstanding year as we continue to realize benefits from prior year investments.

It is important to remember though that we are seeking to build a business that consistently generates higher returns on invested capital over the housing cycle. As such, we will continue to stress running a balanced business.

As I explained on our last earnings call, I see opportunities for us to realize a better balance across the buyer groups we serve. In 2016, roughly 43% of our deliveries were to move up buyers which reflect increased investment in that segment in prior years.

Going forward, there may be opportunities for us to diversify and expand our business among first time and active adult buyers, where the huge booking generations of the millennials and boomers will influence demand for years to come.

Our emphasis on building for the move-up buyer has served us extremely well during the initial leg of the housing recovery. But we want to make sure we aren’t missing opportunities that would allow us to further broaden and grow our business while diversifying risk.

Consistent with this idea of being balanced, our goal is to drive high rates of return, by properly managing the key inputs of sales pace, margin and inventory turns.

We have done a tremendous job improving our margin since 2011, now we have to make sure we are effectively turning our assets in support of delivering high returns by maintaining the right sale and construction pace.

Critical to delivering high returns is that we remain disciplined in our land investment practices and work to be increasingly efficient in managing our land inventories. We have talked often about the 13 point risk waiting criteria that we used to underwrite every deal.

By consistently underwriting projects with returns in excess of 20% as measured by the scale, we can further improve returns and lower our overall risk profile. This risk based approach is now deeply embedded in our operating philosophy and we will continue to do it here to these underwriting guidelines in the future.

As we think about delivering consistent, long-term returns, it’s not just about what projects we are investing in, but how we are investing in those projects. We are actively looking for opportunities to control more land via option.

In 2016, 42% of the lots we approved were initially controlled under some form of option agreement, allowing us to be more efficient with our capital while helping to lower overall risks. Beyond the what and the how of the projects we invest in, is the how much capital we chose to invest.

We’ve talked about previously several years of 30% plus compound annual growth in our land spend has meaningfully improved our land pipeline. As such, we were able to materially slow the growth of investment going forward, while still expanding our business.

We currently expect land acquisition spend in 2017 to be approximately $1.1 billion, which comparable to our 2016 investment ex John Wieland. Given our prior investments, we are in a position to deliver additional volume growth in 2017.

We also expect to realize even higher returns on invested capital, given plans to moderate the rate of land spend, increase the use of land options where possible and accelerate our inventory turns. In 2017, I also expect to take additional steps in our work to raise the bar on construction quality and customer experience even higher.

Though it can be difficult to quantify, I believe improving the products and experience we deliver can over time enhance sales, improve revenues and decrease future warranty costs. As such, it is an opportunity that we continue to pursue. Now let me turn the call over to Bob for a detailed review of our fourth quarter results.

Bob?.

Thanks Ryan and good morning. Our Q4 results represent the completion of an outstanding year for the company, as we realized significant gains throughout our business and resulting financial performance.

Consistent with Ryan’s comments of 2016 being an inflexion year in terms of realizing higher growth, our fourth quarter home sale revenues increased 21% to $2.4 billion. A higher revenue in the quarter reflects a 9% increase in closings to 6,197 homes, along with an 11% increase in average selling price to $391,000.

Our Q4 conversion rate at 66% was slightly above last year and our prior guidance for the quarter.

Our ability to close additional homes reflects a number of factors including our decision to selectively start more spec production earlier in the year, the efforts we’ve made to strengthen our trade base and perhaps most importantly the hard work of all of our employees.

We’re certainly pleased with the steady progress made towards being more efficient in converting our construction pipeline in 2016, but labor resources are still tight across many of our markets. As such, we’ll continue our strategy of selectively including spec units as we plan our product pipeline to help develop a more even construction case.

With all this in mind, we currently expect our first quarter conversion rate to be comparable to Q1 of last year. Looking at the mix of our fourth quarter closings, 30% was first time, 43% was move up and 27% active adult. This is consistent with last year, when the closing break down was 31% first time, 40% move-up and 29% active adults.

As I mentioned, our revenue also benefitted from the 11% increase in our average sales price this quarter. The higher average sales price reflects the ongoing shift in the mix of homes or buildings coupled with higher prices realized in each of our buyer groups.

In fact, our ASPs were up 20% to $301,000 for our first time buyers up 9% to $464,000 for our move-up buyers and up 6% to $374,000 for our active adult buyers.

The large increase in average sale price for first time buyers was driven primarily by mix, as we realized a large increase in homes closed in California which as you would expect carry much higher prices relative to the rest of the country.

With our backlog ASP up 8% over the last year to $296,000, and given the mix of communities we plan to open over the course of 2017, we expect our ASP will continue to move higher through ’17 and is likely to average above $400,000 for the full year.

Before I address our gross margins, I’d like to cover a change in the way we are classifying sales commissions. As we highlighted in our press release, we’ve elected to re-classify both internal and external sales commissions from home sales cost of revenues to SG&A.

This adjustment makes our income statement presentation more consistent with the majority of our home building fears and we believe is responsive to some of the questions and feedback we’ve received over the years.

To assist in your analysis we are posting three years of financial results to our website, each is adjust to reflect the new classifications. Having said that our reported home sale gross margin for the fourth quarter was 24.8%, the comparable prior year fourth quarter gross margin was 27.1%.

Consistent with comments we’ve made on prior earnings calls, margins continue to be impacted by higher land costs as we are turning over almost one-third of our communities each year, as well as labor costs which are continuing to increase across many of our markets.

Looking at the year ahead, we continue to target full year 2017 gross margins of 24% to 24.5% likely still the highest in the industry, as we continue to benefit from operational changes we made as part of our value creation work.

Just to be clear, this range is the same as the guidance we gave previously related to 2017 margins, simply adjusted to reflect our reclassification of commissions in to SG&A.

That being said, given our current estimate for house cost to increase by 1.5% to 2% as well as potential impacts related to affordability due to rising interest rates, we anticipate being towards the low end of guidance range.

Turning upon the demographic and geographic mix of homes closed in a given period, reported quarterly gross margin could range from 23.5% to 25% with Q1 expected to be the low quarter of the year. Our gross margins continue to be supported by our focus on maximizing loss premiums and option revenues.

In fact, total options revenue and loss premiums gained 7% over last year to approximately $73,000 per closing. However, sales discounts of 3.2% or $12,500 per home while still modest, did increase 40 basis points sequentially and 90 basis points over the fourth quarter of last year.

Our reported fourth quarter SG&A including commissions, totaled $208 million or 8.6% of home sale revenues. This includes the benefit of $55 million relating to the reversal of construction related reserves realized in the quarter.

Comparable prior year SG&A spend was $210 million or 10.5% of home sale revenues which included a $30 million benefit from a similar reversal of constructed related insurance reserves. Adjusting for the reclassification of commissions and consistent with our prior guidance, we expect our full year 2017 SG&A to be approximately 12.5% of revenues.

As a result, we continue to expect our full year 2017 operating margin to be in the range of 11.5% to 12%. Turning to our Financial Services businesses, we reported pre-tax income of $25 million in the fourth quarter as the operations benefited from the increase in homebuilder closing volumes.

This compares to $29 million last year, which included a benefit of $12 million resulting from a reversal of mortgage repurchase reserves. Mortgage capture rate for the quarter was 82% compared with 83% last year. In the aggregate, we reported fourth quarter pre-tax income of $414 million, an increase of 11% over the prior year.

For the quarter, the company reported a $141 million of income tax expense, representing an effective tax rate of 34%. The company’s effective tax rate for the quarter was lower than its previous guidance of 38% due to the recognition of energy efficient home credits, as well as a deferred tax benefit related to a legal entity restructuring.

While we’re around the topic of taxes, I’d like to note that we currently expect to fully utilize our remaining federal net operating loss and tax credit carry-forwards in 2017. As a result, we expect to become a federal cash tax payer on a portion of our taxable earnings in 2017.

As we become a cash tax payer, we can take advantage of the section 199 manufacturing deduction which we expect will decrease effective 2017 tax rate by approximately 1.5%. As a result, we expect our 2017 full year tax rate to be approximately 36.5%.

It is important to note that everything we’ve outlined for 2017 assumes that no corporate tax reform takes place. Like all tax payers, we’re paying close attention to dialog related to possible changes to the federal tax laws.

The timing and specific language associated with any tax reform is critical to calculating the potential impacts on our cash flows and the value of our deferred tax assets. As such we have to wait to see the actual legislative before determining future impacts.

Closing out the review of our income statement, net income for the quarter was $273 million or $0.83 per share, which includes $0.16 per share of insurance and tax benefits realized in the quarter.

Fourth quarter earnings per share are calculated using approximately 328 million shares, which is decrease of approximately 7% from 2015, resulting primarily from share repurchase activity. Moving to our balance sheet, we finished the quarter with $723 million of cash.

During the quarter, we spent $252 million to repurchase 13.2 million shares at an average price of $19.07 per share. For the full year, the company spent $600 million to repurchase 30.9 million shares or 8.8% of its outstanding shares. As previously announced, the company plans to repurchase an additional $1 billion of its common shares in 2017.

The timing of planned repurchases will be driven in part by the normal seasonal cash flows of the business and subject to overall business and financial market conditions. Our year-end debt-to-cap was 40% which is within the 30% to 40% range in which we seek to operate.

Depending upon the timing of future share repurchases we may move above 40%, but expected future earnings should work to quickly de-lever our overall cash structure. Let me finish with a few details on our homebuilding operations. At the end of the quarter, we had a total 7,486 homes under construction which is an increase 15% over last year.

Consistent with our strategy to use specs to better maintain our production levels, specs with 31% of year-end homes under construction which is consistent with last year. We ended the quarter with 645 finished specs, as we continue to average less than one finished spec per community.

For the fourth quarter, we generated 4,202 sign-ups which is an increase of 15% over Q4 of last year. On a dollar basis, sign-ups were up 22% to $1.7 billion. Breaking down science by buyer group, sales to first time buyers gained 12% to 1,116 homes, while sign-ups to move up buyers increased 27% to 1,985 homes.

Sign-ups to active adult buyers were 1% from last year and totaled 1,100 homes. Our community count was up 17% in the fourth quarter to 726. Our community count growth was slightly ahead of our guidance due to the slower close-out of a few communities.

As we did in 2016, we again expect turn over roughly one-third of our communities in 2017 and anticipate overall community count growth in the range of 5% to 10% for the year. Year-over-year growth in community should be fairly consistent between the front and back halves of the year.

Supporting this growth, the company continued to invest in the business approving roughly 6,000 per purchase during the quarter, including a replacement Del Webb community in Southern California.

Excluding the 1,000 lots associated with this Del Webb position, our average deal size includes just over a hundred lots that we expect to have a duration of roughly 2.5 years from the time we open for sales. Consistent with the trends we have seen for the past several years, most of these lots will require development.

However, we are pleased to see that over a third of the deals were option transactions allowing us to improve asset efficiency and reduce potential market risk. For the full year in 2016, we spent approximately $1.1 billion on land acquisition excluding the assets we purchased from John Wieland.

As Ryan mentioned, we expect our 2017 land acquisition spend to be approximately $1.1 billion, and we expect to increase our land development spend by approximately 10% to $1.6 billion At year-end, we owned approximately 99,000 lots while controlling another 44,000 lots via auction.

Based our trailing 12 month closing volumes, we’ve lowered our owned lots supplied to less than five years. Our goal is to continue to shorten the duration of our land pipeline by continuing to focus our investment on smaller, faster turning communities, while continuing to work down our large legacy Del Webb communities.

We ended 2016 with a strong land pipeline that can support ongoing growth in 2017. While we have a lot of work ahead of us, as we seek to open upwards of [250] new communities in 2017, we have the required land and are optimistic better opportunities heading in to the selling season.

Now let me turn the call over to Ryan for some final comments on market conditions.

Ryan?.

Thanks Bob. Fourth quarter and full year 2016 results for PulteGroup and the overall US housing market point to continued growth in housing demand.

After several years of strong job formations and low unemployment, supported by favorable demographics, there are signs that housing demand is now being bolstered by an improving economy and recent gains in consumer sentiments.

Against this increasingly positive background, we are mindful that interest rates have been rising over the past couple of months. However, coming off such a low starting point, it is certainly reasonable to expect that housing demand can continue to expand especially if the rise in rates truly reflects increased expansion of the US economy.

We are fortunate that the initial increase in rates took place during the seasonal slow point for housing sales. Buyer expectations have had time to adjust to these new market conditions, so expectations can be properly set as we head in to this spring selling season.

While it is challenging to assess buyer sentiment during the slower winter months, we believe higher rates have so far had minimal impact on demand. We will obviously have a better read on the buyer as we move through the first two quarters of the year. But based on Q4 results, we are optimistic heading in to 2017.

Specific to the fourth quarter, market conditions were generally consistent, albeit at seasonally lower volumes, with the trends experienced earlier in the year. In the east, demand conditions in Florida and up through the southeast generally remained positive.

Demand in Florida remained strong, although our results for the quarter were a little choppy given the timing of community close-outs and openings. I would add that our results showed consistent improvement as the quarter progressed.

We realized improved year-over-year sales volumes in the Mid-Atlantic and Northeast markets, but still view these as very competitive where we’ve had to battle for each sale particularly in DC.

Demand in the middle third of the country remained strong in the quarter, as our Mid-West and Texas operations both posted year-over-year sign-up increases exceeding 20%. Houston was particularly in the quarter, and given the recent gains in the price of oil 2017 could see a sustained recovery in demand.

And finally, looking out west demand conditions were favorable although we experienced some volatility as we move from week to week from the quarter. It is only got stronger as we move through the quarter, while northern Cal slowed a little. That being said, our divisions have a positive view heading in to 2017.

While we are only a few weeks into the new year, we are pleased with the overall demand conditions which suggest that higher rates are not dampening buyer interest and that 2017 can be another year of growth for the industry. Given the good start we are seeing, we are excited to get in to this spring selling season.

Let me close by thanking all employees of PulteGroup. You helped grow the business the right way in 2016 by remaining focused on building a great home and delivering an outstanding customer experience. Together we can look forward to an even bigger and better 2017. Now let me turn the call back to Jim Zeumer.

Jim?.

Thank you Ryan. Just reinforcing Bob’s message, you can find the historical financial results on our website in the financial information section under the investor relations tab. With that said, we’ll open the call for questions so that we can speak with as many participants as possible during the remaining term of the call.

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

Eric if you’ll explain the process, we’ll get started with Q&A?.

[Operator Instructions] we’ll take our first quarter from Nishu Sood with Deutsche Bank. .

I wanted to ask first about the impressive ASP growth, certainly ahead of your peers in the past couple of quarters. And Bob you were talking about how we should expect that to continue in ’17. You talked about entry level, the mix shift to California.

Just wanted to get a sense of how did that effect on the fourth quarter? Just want to understand the drivers of the ASP growth across the divisions or maybe even regionally? What’s going to drive it to stay above 400 in ’17?.

Yeah Nishu, I think it’s a couple of things. Mix matter geographically, so certainly in the fourth quarter this year what drove some of the increase was heavier concentration of California [closures] where prices are higher. In terms of going forward, it’s a continued mix shift to some degree.

We obviously over the last three or four years invested a great deal on the move-up space that has a higher average sales price. As we mentioned in the fourth quarter it was $464,000. So as you see more of those communities opening, you’ll see the price mix higher.

And again as you saw this year, sort of a sequential increase quarter-over-quarter, our expectation is you’ll see the same thing in 2017. .

On the share buybacks, the $250 million a quarter, obviously you’ve been on track with that for 3Q and 4Q. As we look out across ’17 and other that’s coming in to a little bit clear view, how do you expect that to impact the balance sheet? You mentioned that you should be able to deleverage.

Are these share repurchase you continue at this aggressive pace to the tune of $50 million. Is it going to be mostly internally funded? Now you’ve laid out first expectation for 2.7 billion in land spend.

What should the debt-to-cap roughly look like by the end of the year and how is it going to be funded, mostly internally or will there need to be some additional debt raises?.

Nishu, its Bob, I think what we’ve highlighted is we’d like to stay at or near that 40% rate. It’s our belief that we can stay there, we’ve talked about needing to maybe go outside that a little bit. It’s much a function of buying down the equity makes the percentage just naturally accrete higher.

But in terms of the cash flows of the business, yeah we like many in the industry have typically outflows in the first half of the year, as we build house and develop lots that we will deliver later in the year so the cash flow is skewed more heavily towards the back half of the year.

You and should expect us to have that impact the way we buy stock during the year, and so we’ve talked about by the end of the year probably being low 40s in terms of debt-to-cap, and I don’t think there’s a significant need for liquidity. It will obviously depend total closings, cash flow generation, and profitability.

But we think that within the construct of the capital structure today, we think we can manage through it. .

[Operator Instructions] our next question is from John Lovallo with Bank of America..

The first question is the Midwest orders were notably stronger than we were for at least.

Did you guys see any pickup in demand in some of the rust belt states that may have coincided with consumer confidence that was very strong post-election there?.

John, its Ryan, thanks for the question. We continue to like the strength of our business in the Midwest. We’ve got excellent land positions there, we have very good operators, we have nice market share.

And as I noted in my prepared remarks, we did see a bump in consumer sentiment that I think certainly contributed to the strength in the year-over-year increases that we noted in the Midwest section. .

And then order growth, it looks like it was largely driven by community count opening this quarter, and by our estimate absorptions what we know were down slightly.

How are you guys thinking about the community count absorption mix in 2017?.

As I think Bob mentioned John, we are expecting 5% to 10% growth in 2017 that will be balanced throughout the year as we move through 2017.

We noted that our year-over-year increase in the fourth quarter was 17% community count growth, which was slightly outside the range that we had previously provided, which was mostly been driven by the slow close-out of a few older communities.

So we like the community count growth and we’re also very positive about what our absorptions were in the quarter..

So John the absorptions were actually, if you look at the straight calculation down a little bit.

But if you exclude the Wieland communities which we’ve talked about in the past being slow moving, we actually saw roughly 2% increase in absorptions and across the universe that was flattish on the entry level up 2% on move-up and up 5% on the active adult.

So we did some growth there if you take out the impact of the slower moving Wieland communities. .

Next it’s Michael Rehaut with JP Morgan. .

Good morning every one and nice quarter, and I also have to say congrats on the commission reclassification. I guess if it wasn’t known that I’m a homebuilding nerd and I could be so excited about that, that this should put that to rest. And I encourage others, the few remaining builders to follow your lead.

My first question just going back to the sales pace a little bit, and wanted to understand some of your peers have had absorption pace improvement in fiscal ’16. And you highlighted flat on first time and up 2% of move-ups. So just trying to get a sense of where the gap might be that some of your peers.

Is it perhaps geographic, is it more of a pace versus price equation or if there is certain community mix driving that, because I do think that as its recovery progresses particularly on the first time side which we’re seeing a little bit more activity, I’d expect some of the pace improvement to be a little bit better everything else equal. .

Hey Mike its Ryan. I’ll take - there’s a lot in that question, I’ll take a couple of pieces of it and then we may have to come back and clean up some of the loose ends. We’re very proud of the margins that we have and it’s been part of our value creation strategy aimed at driving overall return on invested capital.

Certainly as I talk about in some of my prepared remarks, it’s important to balance the pace and price equation, margins are one component of that making sure that we’re continuing to turn our assets are also part of that component. But we like what’s going on with our business.

We’re turning our assets, we’ve got strong margins, we’ve got strong profitability, we’re growing our earnings. Those are all very good things for our investors and for our shareholder base and we like what we’re seeing. .

I guess second question just on the gross margins. I believe you said pre-reclassification that the margins that you’re expecting in ’17 are much closer to what you’d consider longer term gross margins. So I just wanted to know, if I recall that correctly and if you still view that to be the case. .

Yeah, Mike its Bob. I don’t think we characterize margins as being something that can be, correct my word fixed. They will move overtime, we’ve enjoyed for the last several years really high margins we still do. The market will ultimately dictate where margins go from here.

But we do think we’re operating a little bit differently the way we are creating floor plans, the way we’re underwriting our land transactions, should lend itself to continued strong margins. But it’s important to remember; we underwrite through return and so as an example, the more option transactions we do could influence the margins, mix matters.

The more entry level or first time business we do could influence margins. So, as Ryan said we feel very good about margin profile today. I don’t want to say that it will be here forever though. .

The other thing too Mike that I’d add to Bob’s comments there, we’ve made real improvement in our SG&A leverage year-over-year or going to show about a 100 basis points of incremental leverage.

When you combine a very strong margin profile with some added SG&A leverage, you get down to the operating margin line that we’ve provided guidance of 11.5% to 12% also puts us in a very competitive spot within the peer side. .

We’ll go next to Bob Wetenhall with RBC Capital Markets. .

Ryan I just wanted to see if you could dig down a little bit in to the SG&A leverage. You kind of higher than the peer group, you obviously have a strong operational background.

Are the changes you need to make on the SG&A side a cost management issue or is it just a function driving sales higher and extracting the leverage out of P&L?.

Couple of things that I’d point out, excluding the insurance benefit that we realized in Q4, we’re forecasting lowering 2017 SG&A as a percent of revenue by about 100 basis points as I mentioned, and that’s relative to 2016. So we’re on track to drive meaningful overhead leverage in the business in ’17.

We talked in our last quarter earnings call, part of that was coming from peer growth in the business, part of that was coming from absolute cost reduction.

As to your comment about our cost higher, we believe that part of the difference between us and some of our peers are the investments that we’re making and delivering a superior product quality, as well as customer experience and we think that that’s a differentiator for our company and frankly as part of our strategy, and we believe we get the benefit of that in higher gross margin.

So part of the reason you hear us talk about gross margins, SG&A leverage and then ultimately operating margins and looking at it in totality. What I would tell you about SG&A Bob is, SG&A discipline is going to be a focus of mine.

We have continued room for leverage and it will be a focus of buying to go and get it, and we’re proud of the progress we’re making, but I don’t think - I know that’s not where we’re going to stop, so I’ll leave it at that. .

Bob, it sounds like your gross margin guidance is towards the low end of the range and you also caught out the fact that you got this favorable mix shift towards California which is driving our [ASP], and I’m just trying to understand inside the gross margin, are you seeing a lot of lot cost inflation and inflation on labor and materials, which is offsetting the favorable mix? What’s the right way to think about gross margin? And perhaps I’m wrong on this, maybe it’s an issue versus like a shift to spec or something.

Any clarity how to think about the next 12 months on gross margin would be great..

I think the way you said at the start of that question is right. As we have cycled through, we’re turning over a third of our asset base or a third of our community count each year and so the land that is feeding in to our cost of sales is increasing overtime.

Certainly input costs are rising particularly labor, and so what you’re seeing is, against the backdrop where non-mix adjusted pricing isn’t increasing as rapidly as it was two or three years ago, we’re feeling a little bit pressure because our input costs are going up a little bit faster than the ASP has over the last 12 months compared to say 36 months ago.

So for us it’s a continuation of that theme in 2017. I don’t think you should think about it in terms of spec versus non-spec. We’re not changing our stripes there. We put a little more in to the production pipeline, but it’s only about 30% which isn’t terribly different than it was a year ago. And then mix, the mix question it’s not geographic, right.

Our margin profile doesn’t change that much across different parts of the country. Certainly there’s a little bit of a mix differential entry level versus move up versus the active adult space, and so that influences our margin. But we don’t see that having significant impact next year.

And the other thing that obviously feeds in to our margins is the interest expense. Obviously our interest costs are up in fiscal ’17 versus ’16 because of the capital raises that we did in net in 2016. But we think that essentially gets offset by volume differential so we think it’s a neutral on our margin ’16 to ’17.

So I don’t know if that helps, but all those things factor in, but I would tell you land and input cost particularly labor are the primary drivers. .

We’ll go next Mike Dahl with Barclays. .

Just wanted to go back to some of the comments around the land spend and the balance sheet. And it sounded like just tying a couple of things together would suggest that cash from op should see real nice improvement in 2017, just to get to those balance sheet targets.

So just wanted to get any sense of quantification you can provide on cash flow? And then related to that as you think about, there seems to be a kind of pivot towards a longer journey of improving turns and if there is anything you can give us as far as also quantification for inventory turn targets that would be great. .

I’ll start Mike, in terms of free cash flow generation we haven’t provided any guidance. I think it is fair to say we expect the business to grow in ’17 and against that backdrop not spending as much on land acq in particular but also land development combined that we expect to be cash flow generative this year.

I think if you could take a step back, we are not pivoting away from investing in the business, but what we are doing is spending money today to improve the assets that we’ve acquired over the last couple of years which we think generates growth in closings, and so we’re spending more on development.

So historically if you’d gone two years ago, we were probably 50-50 land acq versus development spend.

Given the numbers that you saw today, that number is clearly moving more towards development, which bodes well for cash generation because what we are doing is improving the assets to generate sales and actually getting a return on our investment which you heard Ryan talk about. We want to be balanced in that.

So we don’t have our foot quite as heavy on the gas for growth for future acquisition, but we want to maintain the growth associated with the investors we made over the last couple of years. .

And Mike as you heard us probably say in the prepared remarks, our ability to do that is really because of the 30% annual compound growth rate that we had on land acquisition investment really starting in 2013.

So the health of our land pipeline is quite robust and we’re setup for very nice success and very nice growth as we move in to the future years. I’ll take the piece or your question that you had on inventory turns. Inventory turns is a huge part of driving the type of returns on investment that we’re looking for.

Land is clearly the biggest investment that we have on our balance sheet and so as we’re going to move the needle on overall inventory turns, the focus is squarely on efficiency of land. You heard me talk about a focus being in getting more efficient and lean with our land inventory.

We provided a few more details on that today, but if you look at our current vintage of acquisitions that we’re making, there’s a heavy percentage of options which certainly help with the goal of driving inventory turns.

The average year supply is near three, even slightly below three and the average size of those excluding a couple of large Del Webb acquisitions are around 100. So we think we are doing some very nice things that are different and going to create enhanced inventory turns for us in the future. .

And that’s what I kind of driving at because clearly this is one of the one of the main levers to drive real improvement in returns over the next couple of years just in terms of how you’re turning the land and managing the owned option mix, and so to follow-up on that because I think option deals have been difficult to come by in a lot of places and for a lot of builders.

So could you give us any examples of successes that you can keep it broad regionally and where are you having the most success walking up new deals on the option side and where are you still seeing some challenges?.

Mike I’ll let Bob take that one, maybe I’ll just chime in with one little overwriting comment, and then I’ll let Bob give you a little bit more color. But 46% of our acquisitions recently had some component of an option mixed in to the transaction. Certainly options are attractive, we strive to get them.

We’re not going to overpay however, solely for the goal of having more options. The goal again is to manage risk, to drive a better and higher return on invested capital. When it makes sense to do options we’re certainly going to strive to do it. I’ll let Bob give you a little more color on some of the geographic. .

Mike we’ve talked about it before. It’s actually - I don’t know that there is a geographic ability to do with the hire in one place versus another necessarily.

They are all individually negotiated, sometimes we chose to put our money partner in between, but that’s a little bit more challenging because return is scarce on a relative basis and they want some and we want some.

What I would offer is, markets where we have good, long, deep relationships with the land community and have high relative market share offer us more opportunities.

We get to see more deals, we see them earlier and so our opportunities there seem to lend themselves to more activity again where we’ve got again a long tenured land team and with good relative market share. .

The next question is from Stephen Kim with Evercore ISI..

I wanted to ask you two questions if I could related to leverage, I guess.

First I was wondering if you could tell us how you prioritize M&A in the current environment relative to repurchases, let’s say, given that your leverage is already now expected to rise above your targeted range this year?.

investment in to our ongoing operations specifically land is priority number one. We include M&A in that same category.

So we look at it very much like a land transaction to the extent that we can do an M&A deal, it certainly gives us in many cases a ready now or a quicker land pipeline versus buying something raw that’s got to go through the entitlement process. The second piece of our capital strategy was to continue to fund our dividend which we are doing.

And then the third piece of that strategy was a share buyback. Given where we were at with the state of our business, we made a decision to announce a $1.5 billion share buyback that’s taken place over the last 18 months. We’ve executed on the 500 million piece of that in 2016 in the back half.

We’re going to continue to execute against that plan for the $1 billion in 2017. But, look, we’re out in the market, we’re looking for opportunities. Certainly evaluation comes in to play when we are looking at M&A, no different than we wouldn’t overpay for a piece of raw land we don’t want to over pay for a potential acquisition either.

I’ll let Bob take the debt-to-cap piece. .

I think the only think I would add to it Ryan just as Stephen is, we’ve also always said that while the guard rails are 30% to 40%, we would go above or beneath them if we saw a compelling reason to do so. But that you should expect us to tell you when we do that and how we expect to get back in to those guard rails.

So, example, if there were transactions that we found compelling that would make up a factor here, push us to a 45% debt-to-cap ratio, we would do that if we thought it was beneficial to shareholders.

Having said that, we would probably expect say as part of that dialog saying here is how and when we would expect to be able to drive that ratio back in to our 30% to 40% range. So certainly they are not mutually exclusive, we can do both.

It really would boil down to Ryan’s point, if we saw a compelling to buy it because we look at it as a land transaction. .

My next question is a little bit more broad about leverage. I think that having gone through the cycles that we all have, I think most people would say and probably the most important thing that we need to keep in mind as a builder is to make sure that our leverage that we’re keeping an eye on our leverage ratio at all time.

What strikes me so interesting right now is that your two largest competitors seem to be prioritizing a more defensive approach I might say to leverage and their current net debt-to-cap ratio is they are kind of moving below their historical norms.

One is way below and the other one is near the bottom end of the range that you would kind of talked about and seems like it’s moving somewhat lower. You all have talked about moving to a balanced approach towards products mix, but your leverage is moving well above peers were not too long ago you were among the lowest in the industry.

So from a leverage perspective it seems you’re essentially almost trading strategies with your peers, and I was wondering, could you sort of articulate for us what you think the essence of the disagreement is or what you see differently and why is this the right time in the cycle to lever up rather than to de-lever?.

Yeah I don’t consider it candidly levering up. I mean we are at a higher rate than we were for all the reasons that Ryan just talked about. We invested in the business including M&A and two deals that were fairly significant capital users, and we are buying back our shares which again was part of the strategy.

And all with it, if you remember back, this was December of ’14 when we did the investor day, we said those are our priorities. And again the guide rails are 30% to 40%. I can’t comment on what our peers are doing.

I think what you’re hearing from most and you are hearing from us as we see continued growth in this space to the ability to earn return on the investments we’re making.

So it’s interesting, I don’t think we are trading out our strategy, we’re executing on it, and we’re at the higher end of our range, but we think that we can de-lever that overtime as we run the business.

So, interestingly if you talk about land approach while we are investing in the business to everything you heard us talk about, we are focused on shorter, faster, turning, high asset efficiency transactions which we think mitigates risk, and I think that’s what you’re getting at, risk management.

We think our strategy fits in that and so not being defensive, I don’t think we really have “levered” up. Yes, it’s a little bit higher, but certainly within the framework that we want to operate. .

Yeah, and Stephen I’d also add to that. When you look at the maturities of our long term debt it’s very attractive.

So certainly we’re paying attention to a number of things, we’re paying attention to what our absolute debt-to-cap rate is, we’re paying attention to what we think the growth of the business looks like, and the cash flow that’s going to be generated and then what those long term maturities are.

And I think when we put all of that in to the soup and we come out with what our strategy is, we like them a lot and we’re running it. Certainly your job is to compare us to our peers and pay attention to the differences, but I think we ‘re running our strategy as opposed to as Bob as opposed to taking someone else’s..

The next question is from Stephen East with Wells Fargo. .

Ryan I’ll come back to with the ROIC question in a minute, but I’ll give you all a change of pace for a second. You are the third builder in three days that the fourth quarter orders are stronger than historical season patters.

So as we look at that, do you all think you’re seeing pull forward going on in the industry or has demand just ramped from the third quarter for you all and if you think for the industry. And then when you look at your segments, could you talk a little bit about it.

I was surprised that active adult was not stronger than it was from an order perspective. So if you could just talk about the three product segments and what you think you all have seen. .

Steven this is Ryan, so thanks for the question, a couple of things here. Let me take the segment question first, when we look at the active adult segment it’s historically a segment that performs better in the spring selling season. If you think where the locations of those communities are, they are in the southern states.

It’s generally the folks that are migrating from north to south. So I don’t know that anything abnormal is going on within that segment, other than it is a segment that I think is highly sensitive to consumer sentiment and consumer confidence levels. We actually saw that get stronger as we move through the quarter.

So I’d expect to probably see some added strength from that buyer group as we move in to the first quarter. As far as, demand and has it been pulled forward? I don’t believe that. I believe that as we move through the quarter, we saw some choppiness.

There was certainly some choppiness and consumer sentiment and consumer confidence lag if you will and maybe even a little bit of a vacuum that was created around the time of the election. I think once we got pass the election, things started to at least calm and folks had a little bit clear picture of what their future might have looked like.

We’ve seen as we talked to our operators and we listen to what’s going on our sales offices. We’re seeing good consumer sentiment and I think that’s a positive thing for not only us, but the entire industry. We saw a little bit of an uptick in interest rates, we talked about that.

We don’t see that dampening overall demand or desire to purchase, and we’re optimistic about what prospects are for Q1. .

And then if you look at the returns and just a couple of questions around this. Are you more focused on ROE or ROIC? And then as you look at the variety of drivers, I know you’ve touched in a variety of ways.

But when you look at all the potential drivers, could link order sort of your focus if you will from incremental volumes, pricing, controlling your SG&A to I know it’s all of those things.

But I’m trying to understand how you all think about pulling the levers the most aggressively to hit your ROIC or ROE targets?.

Stephen, we underwrite ROIC, so that’s the metric that we pay attention to. I think ROE is certainly interesting and something that we look at, but is not the metric that we underwrite to, its’ ROIC. In terms of the levers, I think it’s difficult to say there’s a one size fits all strategy.

Every single transaction is a little bit different depending on the price point, the buyer group, the nature of the land transaction. We do and we are making different decisions on a case by case basis to maximize margin.

Sometimes it’s more price less volumes, sometimes it’s more volume less price, because that’s ultimately what’s going to turn the asset and drive the returns that we’re looking for. I would tell you that we have made a pivot in the way that we are looking at this.

Historically we were probably heavily focused on margin as being the primary driver, and we’re leading the organization to have more of a balance and make the appropriate decisions on pace and price to get the intended outcome. .

The next question is from Alan Ratner with Zelman & Associates..

Ryan I appreciate your comments on the demands, recent trends there and it’s good to hear that deposits outlook and doesn’t appear to any impact from higher so far. I guess just adding on to that line of questioning, your backlog conversion was very strong, this quarter it came in above your guidance.

I know you are not a big spec builder, but I was curious if through the quarter as rates started to move and may be in to January, have you seen any evidence of buyers looking to buy more spec homes or homes that are closer to that delivery date to mitigate a potential continued increase in rates, or has the demand pattern between to be built and spec remain pretty constant over that time period?.

We haven’t seen a huge shift in demand Alan, and frankly we haven’t altered our spec strategy. So if we go back a year ago, we introduced more spec in to our overall production pipeline than what we had been say two years ago or three years ago.

We’re still running at a fairly low rate, and as Bob mentioned we’ve got just over 600 thinner specs which is less than one per community which is the number that we target.

We are still introducing specs in to our system because it helps with production, it helps to even out a production flow with our trade partners and when we can provide them with consistency of work, that’s a good thing. We want to keep our trade partners busy and on our job sites.

As far as consumers go, I think anytime there is a threat or a talk of rates increasing it does create a little bit of urgency if you will to make a buying decision buy a spec, lock an [array], get a loan closed. As I mentioned the fact that we’re still at a very historically low rate that all still works to the buyers favor at the end of the day.

So we didn’t see a noticeable shift between spec and to be built. .

And second question, you made the comments about labor and keeping your trades busy.

I was down in Texas last week and one concern that some big builders down there have is that there is a big pretty migrant workforce base specifically shows up around this time of the year ahead of the selling season and some of these builders were just concerned given all the uncertainty on the immigration policy and the rhetoric that we might approach February and those workers may just not show up.

So I’m curious if you’ve had recent conversations with your trades.

Is that a concern you are hearing on the labor front or has your workforce remained pretty steady and as such are not overly concerned about that?.

Our labor remains tight, but we’re managing very affectively with the labor that’s out there. We’ve got very strong relationships with our trade partners and our division teams are purchasing procurement agents, our division presidents, our VPs of construction.

Our folks on the ground I think have done an outstanding job in managing and maintaining those really strong relationships with vendors that frankly have a stable supply of labor. As far as what’s going to happen with immigration policy, I think we’re watching like everybody in the entire country.

There’s not just our company, not just our industry, I think everybody is looking at what’s going to happen with some of the policies out of the new administration. Immigration is just one of those topics that we’re paying attention to..

The next question is from Jack Micenko with SIG.

Wanted to understand what’s different in your thinking on the margin outlook for ’17 compared to the fourth quarter. You had a nice beat in the fourth quarter, and I think the Wieland drag should be lifted going in to next year.

So wondering what’s behind the commentary towards the lower end?.

Yeah Jack, I guess it’s really a reiteration of what we talked about a little while ago. We’ve got higher land, we’ve higher labor and we knew most of that 90 days ago, but certainly the interest rate increase and the impact on affordability factors in to that. So just on balance, our expectation is that we’ll be at that lower end.

There are still very high margins and always worth it to reiterate, we don’t underwrite the margins, we underwrite the return. And we think it will be return accretive as well. .

And Jack I’d just add, the guidance that we gave a quarter ago was 24 to 24.5. We’re reiterated that guidance. We have steered towards the lower end of it just based on what we’re seeing in our backlog and some of the other factors that we anticipate in 2017.

Our expectations for cost increases both labor and house are in the 1.5% to 2% for 2017, which we see is very reasonable. So to Bob’s point, we have a lot of communities cycling out, a lot of communities cycling in, somewhere on the order of about 250 out and 250 new come in.

So as we work through that, we look at the different margin profiles that’s how we’ve come up with our estimates and we tried to provide good transparency and communication to you all to help with the way you build your models. .

And I think in your prepared you’d said, discounts 90 bps higher year-to-year, 40 bps quarter-to-quarter did I hear it right? And then second, the quarter-to-quarter numbers are almost half the year. Is there a common thread there or is that may be trying to offset some of the movement in interest rate.

It looks like mortgage rates are up above that much in the fourth quarter.

Just curious what was driving the change there?.

Yeah Jack I think it’s a bit of a mixed bag. I certainly think some of it may have been interest rate related. We also had probably slightly, we had a few more specs going in to the fourth quarter than we generally run at and we know just from buyer behavior the margin profile on a home that’s done and sitting on the ground.

This is not as robust as one where a customer can pick out everything that they want to pick out, the way they want to do it. So that’s probably a combination of both of those things.

And Bob I don’t know if you got anything else you’d add to that?.

Yeah, the only thing I’d add Jack is 3.1% in the current quarter, it’s a little over $12,000 a unit, so it is still moderate on relative terms. So to all the points that Ryan made it’s not like we’re seeing it go up to 7% or something like that. .

And this concludes today’s question-and-answer session. Mr. Zeumer, at this time I would like to turn the conference back to you for any additional or closing remarks. .

Thank you everybody for the time this morning on today’s call. If you’ve got any questions we’ll certainly be available over the remainder of the day. Thank you..

This concludes today’s call. Thank you for your participation. You may now disconnect..