James P. Zeumer - PulteGroup, Inc. Ryan R. Marshall - PulteGroup, Inc. Robert T. O'Shaughnessy - PulteGroup, Inc..

Michael Jason Rehaut - JPMorgan Securities LLC Stephen Kim - Evercore ISI Kenneth R. Zener - KeyBanc Capital Markets, Inc. Ivy Zelman - Zelman & Associates Nishu Sood - Deutsche Bank Securities, Inc. Truman Patterson - Wells Fargo Securities LLC John Gregory Micenko - Susquehanna International Group, LLP Carl E.

Reichardt - BTIG LLC Michael Dahl - RBC Capital Markets LLC Susan Maklari - Credit Suisse Securities (USA) LLC Alex Rygiel - B. Riley FBR, Inc. Buck Horne - Raymond James & Associates, Inc..

Good day and welcome to the PulteGroup's Q2 2018 Quarterly Earnings Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Jim Zeumer. Sir, please go ahead..

Great. Thank you, Katie and good morning. I'm pleased to welcome all participants to PulteGroup's second quarter earnings call. Joining me today are Ryan Marshall, President and CEO; Bob O'Shaughnessy, Executive Vice President and CFO; and Jim Ossowski, Senior Vice President-Finance.

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

PulteGroup's second quarter earnings in both 2018 and 2017 included several unusual items which are noted in the earnings release. As part of the call, we will comment on our reported results as well as our financial results adjusted to exclude the impact of these items.

We have provided a reconciliation of these adjusted numbers to our reported results in our earnings release and within the webcast slides posted as part of this morning's call. We encourage you to review this information to assist in your analysis of our Q2 results.

Before I turn the call over to Ryan Marshall, let me remind everyone that today's presentation includes forward-looking statements about PulteGroup'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 Marshall.

Ryan?.

Thanks Jim and thank you to everyone joining us this morning's call. I am excited to discuss PulteGroup's outstanding second quarter results. As I know there are several earnings calls over the course of the day. Let me quickly summarize our Q2 results. On a year-over-year basis PulteGroup's homebuilding revenues increased 25%.

Our adjusted gross margin increased by 60 basis points. Our adjusted operating margin increased by 180 basis points and, most impressive, our adjusted earnings per share increased by 89%. Our top line growth, operating gains and improved returns continue to benefit from solid execution of our established business practices.

While these practices have been refined as the housing cycle has advanced, the core objectives have remained constant. First, we're investing in the business through high returning projects, in fact over the past four-and-a-half years we've invested over $5 billion in acquiring new land assets.

Throughout this period the fundamentals of our disciplined underwriting practices have not changed. Our focus remains on achieving high returns on invested capital as we continue to emphasize investing in smaller, faster turning projects.

Consistent with our focus on returns, we've also expanded our lots under option which are now up to 40% of our controlled lot position to enhance returns and mitigate risks. Second, we continue to realize efficiencies throughout our homebuilding operations.

We are proud of the fact that we're routinely maintained among the highest gross margins and operating margins in the industry. This hasn't been achieved by chance, but by changing core business processes including the integration of extensive customer research into our product design and development.

Our innovative new floor plans are then rolled out through our common plan management platform. I'd highlight that 80% of our Q2 closings were from commonly managed plans. Once in the field, we use the innovative pricing system that we built seven years ago to help maximize higher margin option and lot premiums revenues.

Consistent with these practices we are finishing the market testing of our new active adult floor plans ahead of their national rollout early next year. I would also highlight that during our second quarter we launched our Pulte Smart Home.

PulteGroup is the first builder to offer such smart home technology nationwide in every home that we build while allowing home buyers to select the technology components that best suit their needs.

For some this means basic WiFi, while for others they want to control the entire home including heating and cooling, door locks, garage doors, entertainment and some, even their appliances. And third, we're allocating capital in alignment with the company's stated priorities which includes returning funds to our shareholders.

Our earnings per share and return on equity have been enhanced by systematically returning excess capital to shareholders through dividends and our share repurchase program. Since 2013, we've returned approximately $3 billion to shareholders and have repurchased almost 30% of PulteGroup's common shares.

Of course, all of these initiatives would have been just words on paper without the hard work and commitment of the industry's most talented team. I want to thank all of our employees who work hard every day to deliver the highest quality homes and an outstanding home buying and mortgage experience to our customers.

The business practices we've pursued in combination with the tremendous efforts of our employees certainly contributed to the significant gains realized in the second quarter. The good news is that we see opportunities to get even better, as Bob will detail in a minute.

Given the strength of our business, we are increasing our guidance on several key financial metrics. It would be unwise for us to take all of the credit for the strength of the operating and financial gains. We recognize the favorable macro conditions that continue to surround and support our industry.

As you would expect, when market dynamics include sustained demand and limited supply, prices will typically increase. This has certainly been the situation in housing for a number of years and has only continued as builders seek to pass through higher labor and material costs.

The ability to raise price is obviously positive, but affordability concerns are real, especially given mortgage rates which have been volatile.

We continue to see increased traffic to our websites and to our communities, but the traffic to contract conversion rates eased a little during the quarter, particularly among first time and move-up buyers when mortgage rates rose in May. And while trends improved as the quarter progressed, buyers clearly want to see value in their purchase.

This serves as a good reminder that affordability still matters. To summarize, we remain very positive on market conditions and the ongoing demand for new homes. The country continues to benefit from a strong jobs market, exceptionally low unemployment, modest wage increases, and high consumer confidence, all of which are positive for housing demand.

At the same time, the supply of new and existing homes remains low and continues to run below estimated need. Within these operating conditions, our broad geographic presence, diversified product offering and strong operating platform has the company positioned well for ongoing success.

Now, let me turn the call over to Bob for a detailed review of our outstanding Q2 results.

Bob?.

Thanks, Ryan and good morning. The company's Q2 results represent another quarter of material year-over-year increases and performance gains. As noted in our release, our second quarter results for 2018 and 2017 include several unusual items.

As a result, I will discuss reported as well as adjusted numbers to provide a clear understanding of our underlying business performance. Starting with signups, we reported a total of 6,341 signups in the quarter which was comparable with last year. By buyer group, first time orders decreased 13% to 1,657 homes.

Move-up orders declined by 2% to 2,906 homes and active adult orders increased 16% to 1,778 homes. Traffic to our communities remained high throughout the quarter. The lower signups among first time and move-up buyers reflect the modest slowdown in conversion rates that we experienced toward the middle of the quarter.

As Ryan mentioned, we believe this may have been in response to the rise in mortgage interest rates. The strength within our active adult business, up 16%, demonstrates why we have always worked to maintain a strong presence among each of the primary buyer groups.

Reported Q2 signups were also impacted by actions we took in certain markets and communities to effectively manage lot releases, sales pace, and pricing. While every community is different, at present we generally believe that maximizing price and margin over pace is the best way to deliver long term high returns.

You can see the benefit of this strategy in the strength of our gross margins which are being realized while still growing our expected delivery volumes over last year. Given a 5% increase in community count in the second quarter, absorption pace was down approximately 6% compared with last year.

Consistent with Ryan's comments on the strength of our Q2 financial results, we generated significant gains throughout our income statement. Starting at the top, our home sale revenues increased 25% to $2.5 billion.

Our higher revenues for the quarter were driven by a 14% increase in closings to 5,741 homes along with a 10% or $37,000 increase in average sales price to $427. The $37,000 increase in our average sales price for the quarter reflects pricing gains across all buyer groups.

For the second quarter, the average sales price for first time buyers increased 25% of the prior year to $360,000 while move-up gained 8% to $490,000, and active adult was up 3% to $389,000. We continued to experience pricing strength within our first time buyer communities, but the 25% increase in Q2 was influenced by closings out of California.

As we've talked about on prior calls, we have California communities serving first time buyers often older millennials who are buying their first home with average sales prices well over $700,000.

These are typically townhouse communities on community rail lines where the buyer is likely a software engineer or two working at one of the many tech companies in the area. Looking at our Q2 closings by buyer group they breakdown as follows, 30% first time, 46% move-up, and 24% active adult which is consistent with last year.

In terms of our production universe, we ended the second quarter with 11,845 homes in backlog and 11,158 homes under construction. Of the homes under construction, 8,550 or 77% are sold units with the remaining 23% being spec production.

Given this production pipeline, we expect third quarter deliveries to increase to between 6,000 and 6,300 homes which will represent an increase of 17% to 22% over last year and keep us on track to achieve our expected full year 2018 closings in the range of 22,500 to 23,500 homes.

Given the price increases we've utilized in our signups, we now expect closings over the remaining two quarters to have an average sales price in the range of $415,000 to $425,000. This is an increase from our prior guidance of $405,000 to $420,000.

Continuing down the income statement, our gross margin for the quarter was 24% which is up 60 basis points over the last year's adjusted gross margin of 23.4% and up 40 basis points sequentially from the first quarter of this year.

Note that our prior year adjusted gross margin excludes the impact of the land-related and warranty charges taken in that period. Supported by our strategic pricing methodology, gross margins continue to benefit from higher option revenues and lot premiums.

On a year-over-year basis, option revenues and lot premiums increased 5.5% or just over $4,000 to $79,429 per home. Attesting to the relative strength of the operating environment sales discounts in the quarter fell 30 basis points to 3.2% of average sales price or $14,000 per home.

Given current market conditions, and consistent with our focus on delivering high returns on invested capital, we're finding opportunities to further extend our industry-leading gross margins.

As a result, we're updating our guidance for the remainder of 2018 and now expect Q3 gross margin to be in the range of 24% to 24.5%, and Q4 gross margin to be in the range of 23.8% to 24.3%. This is up from our prior guide of 23% to 23.5% for both quarters.

The sequential change in gross margin from Q3 to Q4 reflects the impact of higher lumber costs which are moving through the system.

We also expect to change, on a relative basis, in the number of closings from certain higher margin communities in California, given current lot availability and our actions to better balance sales, production and lot development in support of support returns.

Looking at our overheads, we also generated significantly better operating leverage in the quarter. Our reported SG&A expense of $226 million or 9.2% of home sale revenues includes the $38 million benefit associated with an insurance related reserve adjustment recorded in the period.

Excluding this benefit, our adjusted SG&A for Q2 was $264 million or 10.8% of home sale revenues. Our current year performance represents an improvement of 120 basis points over our prior year.

Given our results for the first half of 2018, we're reaffirming our guidance that we expect full year 2018 SG&A to be in the range of 10.8% to 11.3% of home sale revenues. This guidance excludes the impact of the insurance reserve adjustment recorded in this quarter.

In the second quarter, we also generated net land sale gains of $27 million, primarily resulting from the sale of two land parcels neither of which was included in last year's actions on non-core assets. The decision to sell these positions reflects our focus on balancing land investments, returns and risks across our portfolio.

For the quarter, our financial services business generated pre-tax income of $21 million which represents an increase of 9% over the second quarter of last year. The increase in pre-tax income for the quarter was primarily the result of higher volumes in our homebuilding operations.

Our mortgage capture rate in the quarter was 76% which is down from 79% last year and which reflects the highly competitive market conditions that exist today. Our reported income tax expense for the second quarter was $85 million which represents an effective tax rate of 20.8%.

Our tax rate for the quarter includes $17 million of net tax benefit related primarily to energy tax credits and accounting method change that was accepted by the IRS during the second quarter and changes in certain state tax laws.

Excluding these items, the company's effective tax rate was approximately 25% which is consistent with our prior guidance. For the second quarter, PulteGroup's reported net income was $324 million or $1.12 per share compared with reported net income of $101 million or $0.32 per share last year.

On an adjusted basis, our net income for the quarter was $259 million or $0.89 per share compared with adjusted net income of $148 million or $0.47 per share last year. On a per share basis, our adjusted 2018 results represent a significant 89% increase over our adjusted results last year.

Q2 diluted earnings per share were calculated using approximately 287 million shares which is a decrease of 27 million shares or 9% from 2017. The decrease in share count is due primarily to the company's ongoing share repurchase activities. Switching over to the balance sheet, we ended the second quarter with $402 million of cash.

During the quarter, we used $53 million of cash to repurchase 1.7 million common shares at an average price of $30.07 per share. In total this year, we've repurchased 3.5 million shares for $105 million and have $489 million remaining on our repurchase authorization. We ended the quarter with a debt to capital ratio of 39.9%.

This is down from 42% at the start of the year and is now within our target range of 30% to 40%. Based on normal operations, we expect our leverage ratio to continue trending lower through the remainder of 2018.

As I mentioned earlier, we ended the second quarter with 11,158 homes under construction which represents an increase of 1,570 homes over last year. The increase reflects higher sold units under production as we continue to control specs, having fewer than 600 finished spec homes across our operations.

For the quarter, our community count was up 5% over last year to 847. This increase is consistent with our guidance of 3% to 5% quarterly growth which we'll maintain for the third and fourth quarters of 2018.

During the second quarter, we invested approximately $352 million in land acquisition and we approved an additional 6,900 lots to purchase of which approximately 57% were under some form of option.

We continue to focus on acquiring communities that are smaller and with shorter durations as the average deal size, including several new Del Webb positions was about 120 lots per community. Through the first six months of 2018, the company invested $640 million in land acquisition and $650 million in land development.

This keeps us on track to invest approximately $2.8 million in land acquisition and development in 2018 which is up 10% over last year. Given the company's improved profitability even with this significant land investment, we now expect to generate between $900 million and $1.1 billion of cash in 2018 before dividends and share repurchase activities.

This is an increase of $200 million from our prior guidance. As Ryan mentioned, at the end of the quarter we controlled approximately 149,000 lots of which approximately 40% are controlled via option.

Based on the trailing 12 month of our deliveries, we have successfully reduced our owned lot position down to 4 years as to make steady progress toward our long-term goal of owning three years or less. Now, let me turn the call over to Ryan for some final comments on market conditions.

Ryan?.

Before we open up the call to questions, let me provide a few comments on the market conditions we experienced during the quarter. As I said earlier, the macro economic backdrop remains favorable as unemployment is low and consumer confidence is high which supports our continued positive view of the market.

Looking at conditions across our regions, demand in our North-Eastern Florida markets remained strong in the quarter while our Southeast markets experienced more volatility. Overall, buyer interest and traffic levels remained high on the East Coast.

Consistent with my earlier comments, we were pleased with demand in the middle third of the country as traffic and buyer interest generally remained solid in the Midwest and Texas. And finally, out West, we continue to see good demand in the markets although reported signups were down for the quarter.

Lower signups reflect price versus pace decisions we made given lot constraints, land development delays and lengthening backlogs in certain markets. Through the first few weeks of July, we continue to see high levels of traffic to our website and in turn to our communities.

In closing, the company has delivered exceptional financial results in the first two quarters of 2018. With the backlog approaching 12,000 homes valued at $5.2 billion in combination with strong gross margins, we're well positioned to report a full year of outstanding performance. Now, let me turn the call back to Jim Zeumer.

Jim?.

Great, thank you. We'll open the call for questions so that we can speak with as many participants as possible during the remaining time of the call. We ask that you limit yourselves to one question and one follow-up. Katie, if you explain the process, we'll get started..

Our first question will come from Michael Rehaut from JPMorgan..

Thanks. Good morning, everyone. First question, I guess addressing probably the area of most interest across the investor base today, in regards to demand trends and the order results that you referred to by segment and also during the quarter.

I was interested in terms of the comments you made that trends improved as the quarter progressed and that you saw a little bit of a slowdown in May which is interesting given that rates did move, but perhaps only 10 bps, 20 bps intra-quarter within that month.

So I was curious if you could kind of give us a sense month by month what the order growth was during the quarter; April, May, June.

And kind of bigger picture also, does this cause you to make any adjustments in terms of your land purchase activity if the demand can be this susceptible to such a small move in rates?.

Yeah. Hey, Mike, good morning. This is Ryan. Good question. What I would tell – I think I've answered the first part of your question which is we saw things get better as we moved throughout the quarter. As I mentioned May was the month where we saw a bit of softness.

To the broader question, I think it really kind of goes to how do we see business overall, and at a national level, I'd tell you that the business is good and buyer traffic to our website, as I talked about in my prepared remarks, and more importantly into the communities remains high. So buyers are out.

They're shopping and then that translates into sales. So that being said, the local conditions matter and we are seeing some variation in demand across certain markets and buyer groups..

Okay. I appreciate that, Ryan.

And I guess just on my second question, first off, if there's any ability to be a little more specific in terms of month by month if June turned positive, for example, that would be I think of interest, but I guess the other part of the coin is you had mentioned that part of the decline or the slowdown in order growth was also due to kind of maybe choosing price and margin over pace.

Given your margins being at solidly above industry averages and you even raised your margin guidance, are you at a point where you want to maybe drive the volume growth, the order growth, do you feel like we're at a point in the cycle now where just kind of moving the ship forward and obviously, given the increased lot position and continued strong land spend that the gross margins are sufficiently strong and you can kind of even just hold gross margins where they or throttle them back a little bit to ensure a steady volume growth going over the next couple of years?.

Yeah, Mike, there was a lot in that question, so let me see if I can touch on as many as parts of it as I can. Our strategy has remained very solid in that we're focused on driving the best returns that we possibly can for shareholders. And we do that by managing the pace and the price levers on a community by community basis.

So we're very proud of our gross margins and this second quarter, I think, is a testament to the great work that we've done on both the sales price side as well as the cost side to create an environment where we do have the best margins in the business.

Volume is certainly a part of that equation and we had a nice quarter in the number of sign-ups that have been generated that have contributed to a backlog that's approaching 12,000 units. So we're continuing to see favorable demand trends, we like what we're seeing in our sales offices and we're hearing from buyers.

As I mentioned, value is something that's really important to buyers, affordability is important. As sales prices have gone up and mortgage rates have ticked up, I think it's the two things in concert that have contributed to a bit of the softness that we saw intra-quarter.

We'll continue to address it on a community by community basis and rest assured that volume will continue to be part of the story for PulteGroup. As far as your question on planned land spend, we don't have any plan change in our land spend.

We're executing well through six months of the year and we don't see anything changing throughout the balance which is reflective of our positive view of the market that I think both Bob and I touched on in our prepared remarks..

Thank you. Our next question comes from Stephen Kim of Evercore ISI..

Yeah. Thanks very much, guys and congratulations on the results. Ryan, I wanted to follow-up on your most recent comment there about the decision to manage pace and price and all that.

I was curious as to what kind of a difference you would need to see in the environment for you to shift the lever more towards volume than what you have seen thus far which has encouraged you to sort of keep the lever very much on the side of profitability and be willing to sustain a slightly negative order comparison this quarter.

Could you just give us a sense for what would be different about the environment that you see that would cause you to shift that lever more noticeably to the volume side?.

Yeah, Stephen, good question. And it really does come down to a community by community basis for us in terms of how we pull the volume lever. We certainly pay attention to all the macro trends, consumer confidence, what kind of resale inventory is available, what kind of new home inventory is available.

Those are all the things that I think play into the decisions that we'd ultimately make on volume.

As we've long talked about, we're looking to drive the best possible returns that we can out of the business and when we look at what our lot availability is, what the size of our backlog is, what the pricing environment is, how we measure up demand conditions, all of those – the local market conditions overall, how a local economy is growing, all of those things play into the ultimate decisions that we make around volume.

So, one of the things that I'd tell you is we've been steadfast in our volume guidance for the year at 22,500 to 23,500 units for the year. We took that up 500 units in the last quarter and, as you heard Bob say, we've reaffirmed that.

So we're still performing very much in line with how we saw the business and we'll continue to look at overall market conditions and make those decisions on a community by community basis..

Great. Thank you for that. I appreciate it. I guess, I was wondering, you mentioned that out West you sustained lower orders but that also was due to the fact that you were seeing some lengthening backlogs and you sort of assessed the landscape out there and so you sort of deliberately lowered some of your volume and order taking.

I was wondering if this was a process in your mind that – and if so, if you could give us a sense of how far into the process you are? And I am specifically thinking about probably your backlog cycle times that you felt like were lengthening to the point where you could probably bring those in a little bit and going slower on the orders, are they right-sized now? Are you at a right level of cycle time such that you can now start to be a little bit more aggressive out West or is this something that you think is going to take another quarter or maybe two..

Well, we like where our cycle times are Stephen.

We're always going to – as a production builder, inventory turns are a big component of how we drive success, so we're always going to work to improve the cycle times of our, specifically our house inventory and more importantly our land inventory, it's part of the reason that we've driving to get our owned lots shorter which we're making great progress against.

As far as California goes, it's really specific to a couple of areas in the West where it was timing of new community openings last year along with some new community openings this year, combined with what was a fairly large backlog of sold homes and so, in that pricing environment and the limited lot availability, a difficult entitlement environment, we've made the decision there to control paces in certain communities and maximize price.

The other thing I'd add, not a huge driver but it's worth mentioning, consistent with our focus of staying closer to the city centers, we have built out of our positions in Fresno and Sacramento which contributed to last year's sales paces..

Thank you. Our next question comes from Ken Zener from KeyBanc..

Good morning, all..

Hi, Ken..

I guess, if you could comment maybe also the order trends, obviously, in focus. We tend to look at order pace sequentially, so you guys were down 11% versus the normal down 3%. I get it. My question is what we're seeing in our A to Z (32:24) report where we look at existing sales inventory, we are seeing rising existing inventory.

And since you just mentioned Sacramento, what we've seen is when existing inventory rises, it tends to have an impact on the new home sales.

We do see that specifically in Sacramento, for example, could you comment if you're seeing a relationship within your markets where you see inventory rising, for example, I think Nashville was up 30% year-over-year now, but are you seeing that suppress your new sales at all in type of market dynamics? Thank you very much..

Yeah, Ken, good morning and thanks for joining us this morning. There is a relationship there and we certainly acknowledge that. The key point there is resale inventory is still below normal.

Normally it would be considered six months, in most markets there is a lot that are 2.5 to 3.5 months, so a slight tick up in that I don't think has a dramatic impact on the new home sales environment. If we saw inventory level start to go over six months in certain markets you'd certainly probably see a bigger impact..

Thank you..

Thank you. Our next question comes from Ivy Zelman from Zelman & Associates..

Thank you. Good morning guys..

Hi, Ivy..

Nice quarter. Maybe you can help provide some clarity on the fact that discounts actually decreased relative to, I guess, the year ago, I think you said 3.2% and the fact that you're seeing slower conversion or the first-time buyer and some maybe reaction to rising rates.

So I guess what I want to understand is while discounts are declining, it sounds like you're not able to see as much conversion and maybe pricing power.

So can you explain that better please?.

Yeah, Ivy. It's a pretty simple explanation that we're sticking to our discipline around pricing and we've got excellent locations, our communities are executed well which is a credit to the wonderful teams that we have in the field operating our businesses and we're still able to do drive some pricing power.

And as I mentioned in one of the earlier questions, it's a big component of driving returns and we like what we're seeing out of the business today.

We're going to continue to pay attention to what's going on in the broader economy and be sensitive to a number of the things that we've touched on as it relates to new home inventory, resale inventory, interest rates, overall affordability, et cetera. But right now, we really like the business that we have.

It was an outstanding quarter for the company that we're proud of. We like what we're seeing with overall traffic demand, and we'll continue to make modifications on a community by community basis as we need to. The other thing that I point out is we don't have a ton of spec inventory which is by design. That's how we run our business.

And so some of the places where I think you're seeing probably more incentives and more discounting, it's probably with those that have strategies that are more heavily dependent upon spec inventory..

Yeah, the one thing I'd add to that, sorry Ivy, the one thing I'd add to that is while it's down 30 basis points, the dollars are about the same, so it's really reflective of our ASP increasing, it's still about $14,000 a unit..

Got it. So just in terms of understanding I recognize the asset that you have and you want to maximize the returns.

The consumer, if you think about that consumer that's buying the first townhome, the older millennial $700,000 whoever it is, are you able to raise price to make that contract – execute that contract or you have to hold price?.

I'm not sure we understand your question..

Are you seeing apples to apples stability in that segment of the market where there is more sensitivity around rates and affordability, are you able to take that same product maybe compared to where you were a year ago and actually raise prices on that $700,000 townhome..

Yeah. This is one where the mix matters. I mean, certainly, you can see our ASPs are up across all buyer segments so, yes, we have had pricing power. I think if you think of the prepared comments, we talked about the fact that we think affordability matters.

So going forward if rates are rising that may be a little bit more challenging but we have seen the ability to increase prices and candidly it's reflected in our margins..

Thank you. Our next question comes from Nishu Sood from Deutsche Bank..

Thank you. I wanted to just first of all clarify on the ASP commentary.

Bob, I think you said $415,000 to $425,000, but I think I heard you say for the last two quarters of the year, is that for the full year or for the last two quarters of the year, obviously the reason I'm asking because you had a very strong performance, sorry, in the 2Q, so just wanted to clarify..

Yeah, that's for the balance of the year, Nishu, not average for the year..

Got it. So what would mix it down again, was there something that drove it quite strongly in the second quarter that's going to reverse kind of mix effect wise in the second half of the year..

Yeah. We had highlighted that California has a number of years of high price points that we talked about in the first quarter as it influenced, had a little bit less in the second quarter as the volume ramps up for the year and the same will be true of the back half of the year, it will be a smaller percentage of the total business..

Got it.

And on SG&A, strong performance in 2Q, why not lower it for the year off of that strength, is there something like the ASC 606 increasing SG&A in the back half of the year or are you just – will the strong performance kind of lower you than the range?.

You know Nishu we've guided to the range that we expect to come in. We have focused a lot on SG&A, we've made a ton of progress year-over-year and continue to do that.

I don't know that you'll ever necessarily see us be the lowest SG&A company because we do make some investments in things around quality and culture of the company that we think are important but we have gotten substantially more competitive with our SG&A leverage and we're very proud of that..

Yeah, the thing I'd add Nishu, is we actually, if you remember we had updated our guide at the end of the first quarter which was reflective of the increase in the volume guide that we had given.

We haven't changed our volume guide and we've talked about that from here forward for all the things Ryan has talked about in terms of how and why we spend our SG&A, it's going to be a kind of a margin game in terms of incremental volume would drive better overhead leverage, we haven't projected higher volumes and therefore we're still comfortable with our range..

Thank you. Our next question comes from Stephen East from Wells Fargo..

Hey, good morning, guys. This is actually Truman Patterson on for Stephen East.

How are you guys doing?.

Good.

How are you?.

Doing well, Truman..

Good. Hey, just wanted to follow-up on the demand side of the world, especially any recent change in consumer behavior.

Really on the pricing side, has pricing started to scare off any customers in any region or buyer segment? I'm really thinking orders fell for the first time buyer and move-up and they also fell in four of your regions, just trying to get your sense on really the pricing side of the world rather than the mortgage rate side..

Yeah. Truman, what I would tell you and I mentioned a little bit in Mike's question, at a national level the business is good but local market conditions do matter. And the example that I'd give you is Texas is doing well as a state, but we saw Houston slow a little bit among first time buyers.

The West is strong from a demand standpoint, but we did see demand in Southern California get a little bit soft, again with those first time buyers.

The Midwest is okay, but demand in Minnesota seemed to decelerate a little bit as we moved through the quarter, and then kind of ending with the Southeast, demand there is holding up, but the higher price points were off a tad. So overall housing demand is okay, but the individual markets do matter.

For us, we did see most of the softening in the lower price points with our first time buyers and I do think that is reflective of a combination of price and mortgage rates, I think both matter. So that particular segment has been strong as of late.

Proportionate to the overall sales price, the increases in lumber packages have had a disproportionate impact on that particular price and so I think not just us but all builders have worked to pass that through to the consumer.

And I think, it's safe to assume that it certainly has an impact on how they see value and what they can afford ultimately at the end of the day..

Okay, thanks guys.

And then I don't know if I heard this in your prepared remarks, did you guys actually give absorptions by buyer segment and then in June with that rebounding did you guys change up any incentives at all in the markets?.

Well, absorptions by buyer group; first time down 19%, move-up down 5%, active adult up 5% which blends to the down 6% for the quarter..

Then incentives?.

Incentives, we've not had any meaningful incentive programs. We've obviously seen in markets people have started talking about national sales. We're not there..

Thank you. Our next question comes from Jack Micenko from SIG..

Hi. Good morning guys. Another demand related question, shocker.

Can you give us sales pace maybe by region, particularly maybe in the Southeast, what was happening in some of the regions you saw the sort of some of the lower order numbers?.

Yeah, Jack, what I'd tell you about the Southeast, as I mentioned in the prior question, we did see a little bit of softness in the higher price points in the Southeast.

But the biggest driver there for us, we've closed out of several of our original John Wieland communities that were acquired as part of that purchase which was anticipated and projected and we simply have not replaced those on a one-for-one basis, so some of what you see in our Southeast numbers is reflective of that..

Okay. And then, the margin on the land sale, it's probably one of the better margins you've seen, I think, back into 2013 or 2014 at least, and it wasn't part of the – it didn't sound like it was part of the modernization effort from maybe a year ago.

What was that and what product segment did you feel like you could sell into a better opportunity?.

Yeah, so you've got a couple of different assets there, out West both of them. One was in a market that we're not actually building in today and so we had an asset that was buildable by us, but we didn't have a production team and so we elected to sell it, and so there was real value embedded in that.

The second was from a community that we had purchased recently actually and really we were trying to balance our appetite for risk in that particular market, so we sold off one of the product series as part of that as a means to just de-risk the transaction somewhat.

And again, in California you've seen price appreciation where you can generate some significant value..

Thank you. Our next question comes from Carl Reichardt from BTIG..

Thanks. Good morning, guys..

Hey, Carl..

I won't ask about demand, I'll ask about margins for a second.

Given the guide for Q4 relative to Q3 sort of that anti-seasonal decline, you talked about lumber, Ryan, can you talk at all about other materials, specifically ones that might be impacted by tariffs beyond lumber tariffs or anything related to labor cost that might be impacting that number or that you might be controlling particularly well and any change there in availability or cost of labor that's meaningful?.

Yeah, Carl, you've got Bob here..

Hey, Bob..

Yeah. Certainly, the cost environment is one we're paying a lot of attention to. Our purchasing teams do a really good job of trying to do two things; one, buy as efficiently as possible and then to try and protect our pricing.

We highlighted that lumber will influence our sequential margins because the pricing increases that we saw and exceedingly high prices that we saw until recently will come into our Q4 production pipeline because of the way we buy lumber.

In terms of the labor market, no real changes there, again I think we do a nice job of making sure we've got multiple trades and multiple sources for most of our things so that we can at least work to try and minimize any pricing pressures there.

With respect to tariffs, I guess what I would point to is in terms of what would impact us, steel obviously is something that is a contributor to our cost base, it's not obviously the biggest and that one we'll probably feel some but on the appliance side we've got long-term contracts that we think protect us from much of that pricing impact.

Cabinets is another one with Chinese production. What we're seeing is some of the producers are already starting to source that from other parts of the world. So we don't think that will have a meaningful impact on us over time.

And it's interesting, if you think about what's happened in the lumber market, we had the 20% tariffs last year, that's already reflected in the pricing. And I guess, on a relative basis, the good news is we came into the year saying, hey, with think that lumber pricing will turn down on the normal seasonal pattern and it didn't, but it finally did.

So we're starting to see some relief there. That won't influence our production until next year, but again on a relative basis, could provide us some tailwind in 2019..

Okay, thanks for that detail, Bob. And then I just want to ask about California and there's a lot of moving parts there.

Can you give me a sense sort of, say, over the course of the next year or so, how will mix change geographically? It sounds like Sacramento, Fresno kind of come out but from a price point/buyer segment plus location, inland versus coastal, I mean I'm just trying to get a sense of whether or not that mix of communities is going to change a lot over the course of the next year, if you could just help me a little bit with that, I would appreciate it.

Thanks..

Yeah, Carl, I think you'll see our mix in California as we move from current mix to next year that mix is going to stay relatively stable. I'll start with our Northern California business. We have moved that business predominantly coastal, near the jobs. I mentioned Fresno and Sacramento we've moved out of.

We did have sales there last year, so going forward that business is predominantly going to be a coastal business. In Southern California where about a 30% coastal, 70% Inland Empire business, I'd expect that to remain relatively stable as well..

Thank you. Our next question comes from Mike Dahl of RBC Capital..

Hi. Thanks for taking my questions. I wanted to start out on a couple of additional demand questions asked a slightly different way. One thing I'm curious about, you cited the option premiums, lot premiums in the quarter on deliveries.

As you're getting through the process with buyers who are under contract getting closer to close, is there anything you can give us as far as whether you're getting any forward looking sense on if this affordability issue is starting to create some deceleration and what buyers are choosing in terms of option packages and also on the mortgage side, are you seeing any discernible shift towards ARMs?.

Yeah, Mike, I'll start with your first question. I'll let Bob handle the mortgage question. The only thing that I'd probably point to with buyers as they become pinched on price, they'll typically take a slightly smaller footprint. We have not seen them necessarily take fewer options in the home. I still think that they want the things that they want.

They're working to find ways to afford those things. Potentially they take a lower lot premium. They don't take the water view. They may take something that's got a lower price tag from a lot premium standpoint.

So as Bob detailed in his commentary, we actually saw increases in both things quarter-over-quarter, so we haven't seen a deceleration in the increases on those items. And I'll let Bob handle the arm comment or question..

Yeah. Essentially, we have not seen a substantive change in that. And I think it's because we've got a perceived rising rate environment. People are not typically going to do that unless they just can't afford not to.

They need to get the cheaper rate, but in the most recent quarter, 6% of our volume, the mortgages that we originated were ARMs for comparison that was 5.7% in the second quarter of last year.

What we have seen though is people are locking a little bit earlier, so we've seen our rate locks at 60 and 75 days increase as a relative proportion of the number of mortgages we're doing, so people are paying attention to rate for sure..

Got it. Okay, that's helpful. And Ryan, I guess, I was referring to hopefully some color on just not the closings that occurred in the quarter, but what the backlog or how the backlog is shaping up as it relates to the option packages and premiums going forward, but the second question. Oh, sorry go on..

Yeah, Mike, I'll let you ask the second question, but we haven't seen a change in there. And as far as kind of our margin profile that's holding steady which I think is part of the reason that you saw us take our guide up for the back half of the year which would, I think, be the best indicator to say, no, we're not seeing a change..

Got it..

And go ahead with the second question..

Yeah. Second question was really specifically around Texas because you've covered all of the country in terms of some of your commentary, but curious there was some deceleration in Texas.

Could you walk us through the footprint a little bit more and kind of broken out by major markets, what you're seeing there if there is any real variation?.

Yeah, the one that I would highlight is Houston, Mike. The other three markets that we operate in, I think, performed according to our expectations. Houston is the one that I think we've seen some change there.

The only thing that I can really point to is that it's a city that went through one of the worst floods and hurricanes that the city and that country has seen in probably a hundred years. I think it's creating some prolonged entitlement and development timelines for new communities.

I think the city is still kind of wrestling and working through some of the damaged homes and the impact that that has on overall supply. The economy there is healthy. It's a healthy economy. So beyond kind of the legacy impacts of the storm, I'm not sure that I can point to any reason why we would have seen softness there..

Thank you. Our next question comes from Susan Maklari from Credit Suisse..

Good morning..

Hi, Susan..

The first thing I wanted to dig a little bit into is the comments around the traffic to your website. I guess, leading to May, was there anything that changed that would have sort of indicated that buyers were pulling back a bit.

And then along with that you commented that it's been strong, but is there anything in terms of the amount of time they're spending on the site or the number of visits or what they're looking for? Any kind of nuances within that that you can share with us?.

No, Susan, nothing that we found to be meaningful to be a predictor, an indicator of current or future demand. Traffic has been strong. The year-over-year increases are up. So we're driving more traffic to the website today than we were a year ago, so overall positive.

We're seeing that same trend continue with the conversion of traffic units to the website that's translating into increased traffic into the sales offices and those are some of the things that we pay particularly close attention to is to see what that conversion rate is from the time folks spend on the website and how that translates into foot traffic..

Okay, thank you. And then, you commented that your new active adult plans you're currently testing those and that's continuing to move along.

But I guess is there anything there, as we think about the need to drive value just broadly and especially maybe with the first time or the entry level kind of buyer that you can eventually take from your active adult communities and maybe roll out to other parts of your business?.

Well, not really. Those floor plans – at a broad level I'd say that those floor plans are specifically designed with that buyer in mind. We have similar types of efforts though under our commonly managed platform where we're doing the same consumer research for our entry level buyers, for our move-up buyers.

It's just the significance of highlighting the new active adult floor plans.

That was the first buyer group that we designed consumer inspired commonly managed plans for and we stated all the way back when we started the program that we would create obsolescence, if you will, and every four to five years come out with the next generation of plans and that's what you're seeing with our active adult plans right now..

Thank you. Our next question comes from Alex Rygiel from B. Riley FBR..

Thank you. I just wanted to confirm, your order activity for first time buyers was soft.

Did this buyer group rebound in June like the rest of the business?.

Alex, as I said, we saw overall improvement in the business. Isolated into one buyer group, we haven't given that commentary, but we did see June better than May, still not great and we've seen July improve again, but probably still a little short of where we would have normally expected it to be..

Okay.

And you discussed Pulte holding pricing? Are you seeing any of your competition that is not holding pricing at this time?.

Well, one of the questions that I answered earlier where we're seeing folks not hold pricing are the builders that have more inventory on the ground. It's expensive to hold inventory. You've got a lot of capital tied up into it.

There's a lot of ancillary expenses associated with finished inventory, so that's where the discounts have traditionally gone and that's what we're seeing. We are seeing a few competitors start to do some national sales which I think is indicative of too much inventory and they need to move it. We're not in that position by design.

It's not the way that we've chosen to run our business and so it's one of the things that allows us to hold our pricing..

Thank you. Our next question will come from Buck Horne from Raymond James..

Hey, thanks. Good morning. A quick question on the land spend. I think you guys are targeting up 10% for the full year.

Should we read that as some sort of – would that be a reasonable proxy for how you think about community count for 2019?.

Yeah, Buck, it's a little early to be talking about community count for 2019. We'll provide guidance on that and, broadly, I think the answer to that is no. You can't read into that because option versus raw, finished. There is a lot of things that factor into that and we'll give you some color on that in the fourth quarter..

Okay, thanks.

And with the raised cash flow expectations for the full year, what's your first priority for where that incremental $200 million is going to this year?.

Yeah, it's a great question. I think, I'd point you back to the capital allocation that we laid out in 2014. First and foremost, if we feel good about the business, we're going to invest in the business. We want to pay our dividend. We would then use excess capital to buyback stock.

The one thing I might add to that now is in a rising interest rate environment we might look at our debt if we thought that that was an attractive investment. And so the one thing I can promise is we'll be thoughtful about how we use that money..

Thank you. At this time, I would like to turn the call back over to Jim Zeumer for closing remarks..

Great. Thank you. I appreciate everybody's time this morning. We'll certainly be available over the remainder of the day if you have any follow-up questions, and we look forward to speaking with you next quarter. Thank you..

Thank you, ladies and gentlemen. This concludes today's teleconference. You may now disconnect..