PulteGroup, Inc.
Q3 2013 Earnings Call Transcript

Published: 24 Oct 2013

[Operator:]

Good morning, and welcome to the PulteGroup, Inc., Third Quarter 2013 Financial Results Conference Call. My name is Sarah, and I'll be facilitating the audio portion of today's interactive broadcast. [Operator Instructions] At this time, I'd like to turn to show over to Mr. Jim Zeumer. You may begin your conference, sir.

[James P. Zeumer:]

Thank you, Sarah. This is Jim Zeumer, Vice President of Investor Relations for Pulte Homes. And I want to thank everybody for joining us this morning to hear PulteGroup's earnings third quarter financial results for the 3 months ended September 30, 2013. On the call today to discuss Pulte's results are Richard Dugas, Chairman, President and CEO; Bob O'Shaughnessy, Executive Vice President and Chief Financial Officer; and Jim Ossowski, Vice President, Finance, and Controller. Before we begin, I want to remind everyone that copies of this morning's earnings release, along with the presentation slides that accompanies today's call, have been posted to our corporate website at pultegroupinc.com. Further, an audio replay of today's call will also be available on the site later today. I also want to alert participants that any non-GAAP financial measures discussed on this call, including references to gross margins and earnings per share after certain adjustments, are reconciled to the U.S. GAAP equivalent as part of the press release. Finally, 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 these 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 Richard Dugas. Richard?

[Richard J. Dugas:]

Thanks, Jim, and good morning, everyone. In preparing for today's discussion, I reread our comments from prior earnings calls. I take some satisfaction in knowing that we will make many of the same claims [ph] today that we have been making for much of the past 2 years. First, we are extremely pleased with our third quarter earnings results, both the absolute numbers and the demonstrated progress we continue to make operating against our value creation strategy. Once again, our quarterly financials show the benefits of initiatives targeted at driving higher returns on invested capital through increased margins, better overhead leverage and accelerated inventory turns. Our Q3 financials show improvement in each of these metrics. On a year-over-year basis, our adjusted gross margin in the quarter increased by 390 basis points to 25.5%. This makes the 11th quarter in a row of margin expansion. In addition to better gross margin, we captured an incremental 90 basis points of overhead leverage. If our income statement showed our traditional operating margin, it would've expanded by almost 500 basis points over last year as a result of the combined improvements in gross margin and overhead leverage. And, although less dramatic in its gain, inventory turns continued to make steady progress and is now approaching 1x for the trailing 12 months. The number can be better appreciated when you put into context of turns being around 0.6x when we started this work just 2 years ago. The significant improvements we realized in our homebuilding operations for the quarter drove a 65% or $69 million increase in our consolidated income before taxes. And this is after having to overcome a $16 million decrease in pretax income from financial services caused by changes in the competitive landscape for mortgage originations resulting from higher interest rates. I purposely highlighted our pretax income to avoid any distortions created by the DTA reversal taken in the quarter. While the benefits of the DTA are many, I wanted to make sure that the gains our operating teams are delivering were clearly visible. The dramatic progress in PulteGroup's income statement metrics are equally matched by the improvements we have realized on our balance sheet. With this quarter's DTA reversal, our reported debt-to-cap dropped to 31% on a gross basis and 12% on a net basis adjusted for cash, which is less than half of what these ratios showed just 3 years ago. The much-improved strength of PulteGroup's balance sheet is allowing us to implement our stated plans to be more balanced in our allocation of capital. As noted in this morning's earnings release, through the first 9 months of the year, we have invested $918 million in land and development, retired $461 million of debt, repurchased $83 million of stock and declared $38 million in dividends. Our improved financial position and operating performance are also allowing us to systematically increase investment into the business with our announced plans to authorize $1.6 billion of land development and acquisition spend in 2014, up almost 70% from our full year spend in 2012. With $1.4 billion of cash and leverage down to 31%, we clearly have the capacity to invest much more into the business, but we have committed to being disciplined in our approach and will not chase volume. Land prices have gotten extended in some markets, and we are willing to be patient and focus on investing only in the smartest deals when putting incremental capital to work. To that last point, let me close out my remarks with a few comments about the overall operating environment we find ourselves in today. I expect it will come as no surprise when we say that conditions in the housing industry changed during the past few months as some consumers shows to step back from the market. Is this recent change among potential buyers the result of higher selling prices or higher mortgage rates or the relentless commentary of political turmoil and economic uncertainty? We would say yes. It is likely that all these changes have resulted in consumers taking longer to make their purchase decision. We have been consistent in our position that housing's recovery off the lows of 2011 was driven more by the reduction in supply than a dramatic rally in demand. Buyer demand since 2011 has slowly but steadily improved, and we expect that the recent slowdown in demand will prove to be a modest pullback in an ongoing, multiyear recovery in housing. It is this expectation which gives us confidence in our decision to increase planned land investment in 2014. We also remain in the camp that a return to a significantly stronger historical level of housing production will require an ongoing recovery in the broader U.S. economy that is slowly developing, a recovery that can produce more and higher-paying jobs. Achieving substantially higher volumes will also require more participation from first-time buyers. This buyer category has historically represented over 40% of housing buyer demand, but continued tight underwriting standards and weak personal balance sheets are holding entry-level buyer participation to below 30% of current activity. All that being said, we expect buyer activity will improve, and we are optimistic that the overall recovery in housing will continue. In fact, over the past few weeks, we have modestly adjusted incentives in a few select communities. This action has helped to generate stronger buyer interest in the back half of September and the first half of October than we had experienced in the weeks prior to these actions. While market conditions may be subject to change, what I can tell you that won't change is our commitment to the company's value-creation strategy and more effective capital allocation. I am pleased to say that PulteGroup's third quarter financial results continue to demonstrate the success this strategy and underlying initiatives are having on PulteGroup's profitability and returns. Now let me turn over the call to Bob for a more in-depth glimpse on PulteGroup's third quarter financial results. Bob?

[Robert T. O'shaughnessy:]

Thank you, Richard, and good morning. As Richard outlined, our Q3 results demonstrate clear and meaningful progress against the number of the operating and financial goals we established with the company. I'm pleased to provide some additional details related to our performance this quarter and to highlight some of the important financial improvements we've achieved. In the third quarter, home sale revenues increased 21% over the prior year to $1.5 billion. The increase in revenues for the period was driven by an 11% increase in average selling price to $310,000 and a 9% increase in closings to 4,817 homes. Consistent with trends we have seen for a number of quarters, the higher average selling prices in the quarter were driven by price increases and the continuing shift in our closings to move-up and active adult homes. For the third quarter, our closings break down as follows

[Richard J. Dugas:]

Thanks, Bob. Before we open the call for questions, I'll provide some color on the market conditions we experienced during the third quarter; but recognize, it's within the context of changes in industry-wide demand that we worked through during the period. By geography, I offer the following views

[James P. Zeumer:]

Thank you, Richard. At this time, we'll open the call for questions. [Operator Instructions] Sarah, if you'll explain the process, we'll get started with Q&A.

[Operator:]

[Operator Instructions] Your first question comes from Stephen East of ISI Group.

[Stephen F. East:]

If we can talk about margins first. You've got a lot of interesting stuff going on, and you're one of the few builders that sort of can control their destiny a little bit in the current market. And that -- a lot of that's through your commonly managed floor plans. So what I'm -- I guess what I would like to understand is, you're 16% into it. You want to take it to about 70%. How long do you think it takes you to get there? And what type of differential -- you talked about both margin and pace. What type of differential to you see in those floor plans versus the non-commonly managed? And along with that, then, you've been pretty aggressive on pricing. How much of that is price versus mix? And how does that change as you move forward?

[Richard J. Dugas:]

Yes. Steve, this is Richard. A couple of things. To give you a perspective on the timing, in the Texas zone, which we're furthest along, we could be upwards of 80% or 90% through there by the end of '14. But our Northeast zone, which is our last one, just got started a month or 2 ago. So probably a 2- to 3-year timeframe for us to get to that 70% number commonly managed. We're going as quickly as we can, but it takes a while to kind of reposition the plans. In terms of the differential, we do see better margins on those products. Depending on the plan, it can be a couple of hundred basis points. But I will also tell you that some of the benefits we're trying to get as early as we can, through value engineering, should cost-ing some of the work that we started a couple of years ago. And then probably one of the things we've been most pleased with in the process is that we're getting better, sales pace from the product. The product is actually consumer validated, and it's, frankly, better floor plans. A good example would be our active adult Del Webb floor plans, where we are completely implemented in our Texas and Southeast zones. And now we're in the middle of converting all our Del Webb product in the Midwest, which we call our central zones, in that product. So we're excited about that. And I think the last part of your question was related to pricing. Yes. Pricing has certainly been a good thing for us this year. We continue to get price in some communities. Although, as indicated, in some, we've had to put a few select incentives in places. Regarding pricing on the commonly managed plans, overall, we've been real pleased with the results we've had there.

[Stephen F. East:]

Okay. And then if you do look at that incentives, I'm interested in -- I assume that's pushed a bit more toward your Centex brand. But what type of incentives are you doing? What's it associated with? Are you seeing buyers take incentives associated with mortgage financing, whether a rate buydown or a closing cost, et cetera?

[Richard J. Dugas:]

Yes. It's mostly with regard to option packages that we've been offering. And it's a very limited number of communities. And frankly, not, we don't believe, significantly material to our overall margin results overall. We've been pleased, and we've been very targeted.

[Operator:]

Your next question comes from Will Randow of Citi.

[William Randow:]

In terms of community count, often, you guys speak of your communities are much larger in terms of scale and size. How should we think about the size of communities in 2014 as opposed to 2013?

[Richard J. Dugas:]

Yes. Will, it's going to be a mix. As Bob indicated, we've got 175 new communities, approximately, we're going to open next year, and they are in all flavors and sizes. Generally, a little bit smaller with regard to sort of our legacy book, if you will. But we still have a large portion of Del Webb communities that have a long legacy book out in front of them. And as Bob indicated, we're seeing better results from the Del Webb category. So probably not materially different than this year, relative to the overall mix of communities and size, which is one of the reasons we continue to highlight that, that's not the best metric to drive our business.

[William Randow:]

And as a follow-up, as you bring on those communities, given their vintage might be a bit newer, so to speak, how do you think about gross margins relative to your very strong number today going forward?

[Robert T. O'shaughnessy:]

Well, when we buy, we focus on returns. So as we acquire land, we're somewhat agnostic to margin. We're thinking about what's the return capability. So some of those communities may have a -- I'll make up a number, a 20% margin but a 30% return. And similarly, you could have a transaction that has a 27% return with 25% margin. So yes, the mix will matter. Again, what we're really trying to work through is how to get the highest return out of each land asset, Will.

[Operator:]

Your next question comes from Ivy Zelman of Zelman & Associates.

[Alan Ratner:]

It's actually Alan on for Ivy. Bob, just on that last comment, then, on the return threshold for underwriting. So based on your comments earlier, that seems like a lot of the land that you're buying now or targeting now is more raw in nature and maybe is more geared for 2015 and beyond. Should we expect, then, that, given that return focus, that maybe the margins on those assets should kind of come in line with where you're at today as opposed to maybe more finished lots, if you were buying those, which could be lower margins?

[Robert T. O'shaughnessy:]

Well, it's hard to answer that intelligently because the market moves. The price -- market has improved in the last 2 years. So the assets that we bought then, even if they were finished lot option deals that we didn't expect great margins on, and we're getting them -- so again, as we look at this, I would tell you we're finding transactions and approving transactions that meet our return requirement. Some of them are going to be higher margins than others. It really varies on how we're buying land.

[Richard J. Dugas:]

Alan, this is Richard. I'll add one thing. We generally have seen higher margins on the deals that we've acquired over the last 2 or 3 years than from our legacy book. So we're pleased with what we've been able to find. I think it's partly a result of the fact that we've been what I would say is very selective with our land acquisition strategy. And then just lastly, it's not directly related to your question, though, we do see opportunity for margin improvement from here in the next few quarters that we have visibility into.

[Alan Ratner:]

Great, that's helpful. And then the second question is, Richard, I was hoping you might just be able to expand a little bit on the comments you had in the press release regarding the fact that you see this slowdown as ultimately being short lived. And it sounds like you're encouraged by some of the trends you're seeing in response to the select incentives you're offering. But just curious if you can expand upon that a little bit, and what gives you that confidence that this is more of a short-term issue?

[Richard J. Dugas:]

Listen, we believe that the economy is continuing to show slow and steady progress. We're not in the camp that it's going to get euphoric anytime soon. But we still have very limited supply of housing out there. That's a key driver. We still have, on a relative basis, low interest rates. In hindsight, I think the speed at which rates went up was as big a factor in the pause that we've seen as much as the actual rate increases themselves. And then, when you combine that with the fact that entitlements are taking longer in general, I think all builders are commenting on that, I don't see a huge influx of supply coming on the market anytime soon. So with slowly but steadily improving demand and supply being held in check, we're optimistic as we get into next year. I think the pause that we've kind of recently seen is not necessarily a bad thing over the long run. So we're in the camp that it's likely temporary.

[Operator:]

Your next question comes from Michael Rehaut of JPMorgan.

[Michael Jason Rehaut:]

First question, on sales trends. The commentary around some of the more recent turn, I guess, or some of the improvement in September-October was helpful. I was hoping to get a sense of how order trends progressed throughout the quarter and if -- we had another builder report yesterday that August was, in fact, the strongest month that they had in the third quarter, if that was something that you saw as well or might have seen that perhaps there might have been a more steady or even slowing cadence throughout the quarter if you felt the need to do some of the modest incentive changes to drive a little bit more sales in September-October. So I was wondering if that's the case for you guys and maybe if you could give any type of quantifiable granularity in terms of what type of improvement you actually saw in the last 4 to 6 weeks.

[Richard J. Dugas:]

Yes. Mike, this is Richard. Our trends were generally stable through the quarter. We saw things modestly slow through the quarter, although, as noted, when we added a few, and I want to emphasize a few, very select community incentives kind of in the mid-September range, we did see that help our absorptions at the end of September and into October. When you kind of look at it overall, it was a reasonably flat performance over the quarter with kind of a slight trend down through the quarter until we got to the last couple of weeks of September. And I think it's reflective of pricing that was quite high in some communities, along with buyer concern over rates. And some of those things appear to begin to ebb as we got to the end of the quarter into early October. But I don't have any specifics in terms of numbers for you.

[Michael Jason Rehaut:]

Okay. And I guess the second question, just on maybe a little bit more technical, but interest expense amortization was about flattish. It's been roughly flattish year-over-year as a percent of revenue for the last couple of quarters. How do you expect that to trend? I guess, maybe more a question for Bob. And would that be affected at all by the increase in land spend as a percent of revenue as you go forward? And I think, just if I could sneak another one in on this topic of -- more technical, but on the sales commissions, including in -- included in COGS, you guys are only 1 of 3 builders out of 15 that we follow that put that in that line item. And without it, if you had it in SG&A, I think it would not only make your gross margins more comparable, in a positive sense, to your competitors, but also allow the SG&A to be more comparable as well. So just any thoughts on making that adjustment? Another builder in the last few -- a year or 2 ago made that change, and we found it pretty helpful.

[Robert T. O'shaughnessy:]

Okay. Mike, I will answer the second one first, if that's okay. We -- you had raised this, I think it was, a call or 2 ago, and we said we'd look at it. And we did, actually. And what we found was that, although you see some people doing that, there's inconsistency between internal and external commission. And so I don't know that you'd get -- even if we switched, it doesn't -- it would depend on how we switched. And you wouldn't get consistency throughout the space, anyway. So again, we'll always continue to look as to how we report versus our peers, but we're pretty comfortable with where we are. And then on cap interest, the good news is that because of the deleveraging that we've done, our cash interest expense is down about $15 million quarter-over-quarter and will continue to trend down as we've paid down our debt. As it relates to the amortization, it's really not a revenue-based concept. It's -- we have given some guidance coming into the year that cap interest expense would actually be up this year by about $60 million. That's based on closings, essentially. And so it's weighted towards the back half of the year. So if you look year-over-year, the amortization of interest expense was up $11 million in this quarter versus last year, which is about 20%. And you would expect to see, based on closings, higher interest expense next quarter to fill that bucket of the incremental $60 million that we talked about at the beginning of the year. Going forward, I think it is fair to say we will see a decline in interest expense amortization. We've got less capitalized interest to amortize, and we're capitalizing less as we go. So I think you'll see a benefit on the income statement related to interest next year.

[Operator:]

And your next question comes from Bob Wetenhall of RBC Capital Markets.

[Robert C. Wetenhall:]

I wanted to ask Bob. You guys got very aggressive at doing a strong job of managing the balance sheet. Gross debt's at 31%, and then net debt's down to almost 10%. You mentioned the large cash position of $1.3 billion. You have lower debt levels. So I just wanted to see, from a capital allocation standpoint, with that $1.3 billion, is that money going to be put mostly towards share repurchases, dividends or land investment now that the debt's basically gone?

[Robert T. O'shaughnessy:]

Good question, and it is one we've spent time thinking about. We've indicated, and consistently, I think, that we think the best place to invest is in the business. We get the best return there and continue to believe that. But as Richard highlighted, we want to make sure that we're buying the best land assets that we can to drive the best returns over time that we can. And so our belief is that, if we try to invest too quickly, some of our managers would likely be forced to take the third or fourth option, which might be okay but not great. And we'd prefer to stay in stuff that we feel really comfortable with. As it relates to dividends and share repurchases, since we have a big cash position, we can make selection almost exclusive of what we think we're going to do on the land side. Obviously, we've lost some stock last quarter at about $15.79 a share and have obviously now got the dividend going. That's something that we would look at and talk about internally with the board, but mutually exclusive decisions.

[Robert C. Wetenhall:]

Really helpful. Just wanted to touch -- you've made tremendous progress in a pretty short period in gross margin improvement. And you've also done a really good job of leveraging fixed cost and SG&A. On the SG&A side of the story, is there room for improvement, or are you guys kind of at the outer end? I think you're on track, probably, for like $575 million of SG&A. How do you want us to think about that going forward?

[Richard J. Dugas:]

Yes, Bob, this is Richard. Listen, we think we've done a really nice job. The leverage is certainly going to somewhat volume dependent. We'll have to kind of see how the year unfolds next year. If you're asking do we plan gross SG&A levels to come down from here, I don't think that's very likely. On the other hand, we want to monitor SG&A. So I guess the way I'd think about it if I were you is we are extremely committed to an ROIC story that is driven by gross margins, SG&A leverage, inventory turn. So I'd look for us to pay attention to all 3 of those.

[Operator:]

Your next question comes from Adam Rudiger of Wells Fargo.

[Adam Rudiger:]

I was interested in the comments that you had about the increased competition from outside lenders and the lower capture rate. Another builder that reported this week actually had, I think, amongst the lowest capture rate we've seen in 10 years or so. So can we interpret that or -- as a kind of increased, improved lending from outside sources and some better mortgage availability? Or, I guess, what are your comments on mortgage availability?

[Richard J. Dugas:]

Our perspective is it hasn't changed much. And in particular, for the first-time buyer, it hasn't changed much. QM has codified what people can approve as a loan. Essentially, what we think is happening as it relates to competition is, as rates went up, the refinance business that the banks had been very aggressively pursuing dried up. You've seen some of the headlines about some of the downsizing of workforces at the big banks that were big mortgage originators. And so they've got machines that need to be fed, and so I think we're pursuing new money originations. And so we've had to compete with them in order to retain the business. And we like the business because we think it protects our backlog. So it's forced us to be -- try and be more competitive on rate.

[Adam Rudiger:]

Okay. Second question, just on Del Webb. I'm wondering if you could elaborate a little bit on some of the trends you're seeing there. And particularly, I was curious about the -- I think it was Slide 5, which had the price increases. I mean, should we interpret those that -- the Del Webb price increases being the largest amongst the 3, is that where you're seeing outsized improvement?

[Richard J. Dugas:]

Yes. Adam, this is Richard. I would suggest a couple of things. Number one, the buyer has historically been a little bit later than the other buyer categories to sort of return to the market. So we're not surprised that Webb continues to, at this stage, begin to sort of come into its own. And we are seeing better results there. And, as you'll rightly note, we have quite a bit of leverage opportunity if it continues. The other piece I've mentioned to you is the commonly managed plans. We have chosen to begin our efforts with the Del Webb product, and we have had nothing short of fantastic results in both Texas and the Southeast, where we've introduced our new commonly managed active adult Del Webb product. I mentioned earlier, we're rolling that now to the Midwest, and we expect to have it in the Southwest at some point early in 2014. So as time goes on, we think we've got an excellent product offering to meet what's hopefully a growing demand category.

[Operator:]

And your next question comes from Eli Hackel of Goldman Sachs.

[Eli Hackel:]

Can you just talk a little bit about the land spend that you're going to do, maybe give us some idea in terms of the land you have ready for 2014? And you mentioned you're going more into raw land. Maybe from the additional dollars, the $1.6 billion you think you may spend next year, maybe where that's going to be mostly concentrated?

[Richard J. Dugas:]

Yes. Eli, this is Richard. We are being really disciplined with our process, as we have been. So we're using our risk-weighted criteria. And frankly, that's leading to a pretty diverse implementation of land spend across the system. Places that we've underinvested in the past, we continue to invest in to help position ourselves. A good example is Minnesota. We've highlighted before, we've put quite a bit of money into Minnesota. Georgia, actually, is a market that has recently, the last 6 to 12 months, come on. We're putting a good bit of capital to work there with really good results. So it's not just one market, if you will, that's getting the lion's share of the investment. With regard to 2014, I think it's fair to say that we have limited to virtually no ability to impact '14 at this point with land. The dollars that we're putting to work now are for '15 and '16. So again, we're really pleased that our community count is going to be stable next year, all year, which shows that we're able to get some of the increased investment to work a little bit sooner than we have planned for. And we're happy because the investments that we're making, we believe, are very high-quality investments.

[Eli Hackel:]

Great. And then just one quick one. I don't know if you said it or I missed it, but what was the cancellation rate in the quarter?

[James L. Ossowski:]

The cancellation rate in the quarter was 18%.

[Operator:]

Your next question comes from David Goldberg of UBS.

[David Goldberg:]

My first question is actually for Bob. I wanted to talk to you about the share repurchases in the quarter and this concept of intrinsic value and return on share repurchases relative to buying land and reinvesting in the business. And what I'm trying to get some color on is just how you got to 5.3 million shares, essentially? What was the math that kind of got you there that told you that, that's the right amount relative to more or less and relative to the overall balance sheet? I'm just trying to understand how you compare the 2 better.

[Robert T. O'shaughnessy:]

Well, it's not as if we set out to say we want to buy x number of shares. And so it's not a programmed trade. Essentially, what we do is we look at the activity that we're seeing in the market, or we looked at the activity we were seeing at the market. Clearly, when we set the program in place, we talked about, internally, what levels we were comfortable buying at. And so over the course of the trading period, it just sort of happened that, that was the volume that we were able to acquire at prices that we were comfortable with.

[David Goldberg:]

And in terms of the return differential between the 2, when you, again, kind of get back to the intrinsic value, can you just get some more clarity on kind of how you think about one versus the other or how much more it has to be to reinvest in the shares versus in land specifically?

[Robert T. O'shaughnessy:]

Well -- and remember, they're separate conversations at this point because of our cash position. So it's not as if we're saying we are going to acquire stock in lieu of investing in land. We are investing in land, and that's a process that we go through, and we're buying back shares. And so it's not as if we're borrowing to do it that puts us in a position to make an either/or choice.

[Richard J. Dugas:]

And David, to maybe add a little more clarity, we believe that over a period of time, the balance that we're showing with regard to the priority being toward land investment when it makes sense in the smartest deals, and then other uses of capital returned to shareholders in addition to that, we believe, will drive the best ultimate long-term shareholder return. So just to reiterate to Bob's point, it's not an either/or. It's a combination. And we worked ourselves into a position where we can be very flexible.

[Operator:]

And your next question comes from Stephen Kim of Barclays.

[Stephen S. Kim:]

Good progress on the margins. I wanted to follow up on your comment about anticipating that future communities that you're going to be opening are going to be primarily looked at on a return-on-capital basis, which obviously -- which makes a lot of sense. But I just want to understand a little bit better in terms of how you think that might play out. So it would be my expectation, and I'm curious if you share it, that as you go forward into late 2014 and into 2015, that mortgage availability should broaden out a little bit. I certainly hope so. And if that's the case, you'll probably see a bit of mix shift where you'll see some more buyers who may be more towards the entry-level side come into the market. And I was curious, first, do you sort of agree that, that is the way things may play out over the next 18 months? And if so, do you think that, on balance, your communities would be more skewed towards a little bit of a higher-turn, lower-margin-type business model? And then the second thing is, do you have -- do you feel like you've got that in your pipeline of projects to be able to accommodate that shift?

[Richard J. Dugas:]

Steve, it's Richard. Most of the investment we've been making is in that Pulte brand, with some select Del Webb investment and select Centex investment. So I would suspect that we're going to continue to get really good returns on projects. But by nature of the investment, if you had to say is it going to be more margin- or a pace-driven, because it's Pulte or Del Webb, I would suggest margin would get as much play versus the turn side. In terms of mortgage availability, and it's accommodation for the first-time buyer, as Bob indicated, it's still tight out there. The QM rules have sort of defined the underwriting box. And credit is not particularly easy to get for that buyer category. And I suspect that's partly why we're not seeing the best return opportunities in that category. So we certainly hope that, that opportunity presents itself. And we'll continue to play in that space, clearly. But I'd suggest the majority of our business is going to be driven by the Pulte and Del Webb side over the next 12 to 24 months.

[Stephen S. Kim:]

So I mean, clearly, Richard, you're correct that the environment today is more challenged in terms of mortgage availability because of the reasons you mentioned. But I think if -- will it play out -- if, over the course of the next 2 years or so, you do see a broadening and some improvement of that situation, how prepared is Pulte to be able to react to that changing buyer mix that you see actually visiting your communities? I would think that, because you have a relatively long land supply, there probably are some communities that maybe are a little bit further flung but -- and also, therefore, maybe more suitable to a Centex-type product mix. I'm kind of curious, first of all, is that supposition correct that some of the older projects you have, maybe from pre-2010, would fit that kind of a buyer? And then secondly, how quickly would it -- could you sort of react to activate those and get models up in the air?

[Richard J. Dugas:]

Steve, I'll try to answer as best I can. Most of the acquisition we've done over the past 2 or 3 years has been communities that have a 2-, 3-, 4-year life. So I would suggest that the long-lived land assets that we have are going to continue for a while, and a lot of those are in Del Webb. So those -- that specific small group, but they have a lot of lots associated with them. We clearly could not modify to accommodate the entry-level buyer. On the other hand, we'll be cycling through, as Bob indicated, 175 new communities next year. I don't know how many in 2015. I would suggest we can be reasonably flexible with regard to new investment. But I think to turn existing investment from one category to another is probably not that easy.

[Operator:]

Your next question comes from Dan Oppenheim of Crédit Suisse.

[Daniel Oppenheim:]

I was wondering if you can talk a little bit in terms of the land investments relative to what you're seeing on the sales side in the sense that, clearly, I think most everyone's in agreement there's hopefully going to be a short-lived slowdown here. But what is it that you're looking at as you think about sort of increasing land spending? What are the factors that you're thinking about that give you the confidence, aside from thinking, okay, it should be still the third or fourth inning here. How do you look at that in terms of tempering the -- just thoughts in terms of just boosting the land spending?

[Richard J. Dugas:]

Dan, I'll answer that as best I can. I'm not sure I get exactly the question. But we are seeing some really high-quality assets that we're investing in, so we feel comfortable investing in those. We also continue to continually canvass our operations in the field. And they believe, using the very selective, disciplined criteria we have, that they can put money to work in a relatively low-risk way. So while we are an increasing investment, and clearly we are, we're not throwing the kitchen sink at it. We're being very selective. So I feel like the discipline that we have is very helpful. The other thing that certainly gets us more comfortable is the fact that our operational progress, if you will, our mousetrap is much more efficient than it was 12 or 24 months ago. I mean, we're getting exceptionally good returns, we believe. And that gives us increasing confidence that, provided we're smart with our land buying, we can make it return for us. Certainly, we have more confidence in that now than we did a couple of years ago.

[Daniel Oppenheim:]

Great. And I guess, following up, I'm wondering in terms of the land investments, you talked about the margin's likely to be up over the next several quarters, so room for improvement there. I'm wondering, in terms of the underwriting and in terms of new land investments, presumably those -- the underwriting margins are below the current margins. Is that correct?

[Robert T. O'shaughnessy:]

It depends on the nature of the transaction. Some things that we've underwritten absolutely have lower margins than we're experiencing today. Some are at or higher than. It all depends on the return characteristics of the specific transaction.

[Operator:]

Your next question comes from Jay McCanless of Sterne Agee.

[James McCanless:]

First question, just wanted to ask, on the new communities that you're underwriting for '14 -- and I don't know if you all write them this way or not, but is there an expectation that the per-month orders or the per-quarter orders of these newer communities are going to exceed what we're seeing in the '13 results now?

[Robert T. O'shaughnessy:]

Essentially, when we underwrite a transaction and -- our expectations are predicated on pricing and paces. When we underwrite the transaction, we are assuming paces consistent with market at that point in time. And so most of the things that will open in '14 were bought earlier, and call it 18 months ago or so. And so I think you'd have to look at that time frame. Paces are up, I think, versus what they were 2 years ago. So the pace expectations, we think, we're pretty comfortable with.

[Richard J. Dugas:]

And, Jay, to be crystal clear, to answer that another way, if you look into '15 or '16, which we're buying land for now, we're not assuming pace or price changes from what we have today. It's a static view in the way we look at it.

[James McCanless:]

Okay. And then just wanted to dig a little bit deeper into Del Webb. Are you starting to see -- you said -- it sounds, and correct me if I'm wrong, it sounds like your opinion of Del Webb and that business right now has improved versus the second quarter conference call. Are you seeing the opportunity to start raising price now? Or was this plus 10% this quarter just a mix change, more options, et cetera?

[Richard J. Dugas:]

Yes. Jay, it's a little bit of both. And frankly, in some Del Webb communities where we have 2,000 lots left, we're much better off driving pace than price. In other communities, I can think of one in Charlotte where we're winding down the last phases, we're driving price really hard because we only have a year or 2 left before we open up a new community. So it's a blend. I would say the general trend is we prefer pace over price to drive higher returns in Del Webb because of the lot count we have associated with them. Having said that, that buyer category is probably the least price-resistant regarding options, regarding premiums or even base price. So we're trying to be smart about it. And you saw the results of that in Q3.

[Robert T. O'shaughnessy:]

Yes. The only thing I'd add to that, Richard, is average selling price in Webb is up quarter-over-quarter since last year. So consistent price increases there.

[Richard J. Dugas:]

Yes. It's a good business for us right now.

[Operator:]

And your next question comes from Ken Zener of KeyBanc Capital Markets.

[Kenneth R. Zener:]

Builders are generally price takers rather than setters. You just follow the overall market. So if price is going to be kind of settling down a little bit, can you give us a sense of -- how do you create your value benchmark? What actually drives your decision in those areas where you started doing some incentives to go after? And what kind -- type of elasticity did you see?

[Richard J. Dugas:]

Ken, I'll challenge your opening comment a little bit, if you don't mind. This is Richard. We implemented a new pricing strategy a couple of years ago where we started dissecting every single component of price. And I think most of our operators would tell you we are among the price leaders in markets today. And frankly, given the fact that we're dissecting all the pieces of price, we think, kind of like the airlines are charging you for every little individual option or seat choice, we're getting lot premium, we're getting margin -- or excuse me, we're getting base price, we're getting option revenue, and we're lowering discounts where we can. And while that sounds very rudimentary, we were not as disciplined in that years ago. So I would tell you we are doing our best, and it fits with our strategy. We have not been as aggressive as some peers with regard to acquisition of land. We're trying our best to maximize the value of what we have. We feel it fits our disciplined land strategy. So I just wanted to start out by saying we believe, in our case, we're a little bit of price takers. Having said that, we obviously operate in a competitive environment. And we're not unique overall. So we've had to be responsive, but even with the selected incentives that we introduced here in the last 6 or 8 weeks, I'll emphasize it was very selective. We were very conscious not to go across-the-board and just say, "Let's lower price x percent just to get more volume." It was extremely targeted. So sorry to be so long winded. I hope that helped.

[Kenneth R. Zener:]

No, no, that's fine. I guess my second question -- this is what I've been struggling with is I look at the homebuilders, while margins obviously have surged, along with prices, what we see when we look at a builder's absorption pace, actually, is historic seasonality. So seasonal, not cyclical, growth. And your quarter kind of exhibited that, if we look at the pace change quarter-to-quarter. How should we think -- or how do you guys internally think if you're on pace? Historically, your absorption pace flows about 10% in 4Q versus 3Q, and then it's up 35% in 1Q. And we saw a lot of that normal seasonality. How do you guys think about, if we see the normal seasonality, absorptions are the same, your community count basically flat year-over-year next year, and I do appreciate that guidance, but I mean, without the absorptions moving up, and we don't see anything outside of normal seasonality right now, I mean, where do you get confidence that the volume next year would be up for you guys if you're not going to get it in the pace?

[Richard J. Dugas:]

Yes. Ken, again, we're not giving volume guidance for next year at all. But here's what I'll tell you. The way we look at that is by community-by-community. We have some communities right now, frankly, where we're sold out through Q2 of next year. There's no reason to drive pace or to focus on any incentives there. We have other communities where we've got a couple of more homes left to sell yet for December closings. There, we would be a little bit more selective in focusing on pace. So it's very difficult to give you a generalized answer there. It's more community-by-community.

[Operator:]

Your next question comes from Mike Roxland of Bank of America Merrill Lynch.

[Michael A. Roxland:]

Most of my questions have been asked, but just wanted to guess, Richard, on your comment about entitlements taking longer, what have you seen as the biggest impediment, and how much have cycle times been extended as a result?

[Richard J. Dugas:]

Yes. It's municipal staffs, frankly. After the downturn, it doesn't appear that a lot of municipalities have ramped up their hiring enough to keep up with the demand. So it's not just the rate of dollars that you want to put into the market, it's the actual pace at which you can get communities open. And we're seeing those slip 2, 3, 4 months relatively routinely. And it's municipal delays in both the entitlement process, as well as sort of the final approvals on your final construction plans for land development, things like that. To be honest with you, Mike, not unexpected. I think, if I could guarantee anything over the next several years, it would be that entitlement times will get lengthened in this industry. It just seems like that's the way it works.

[Michael A. Roxland:]

Got you, okay. And then just a last question on price. Outside of incentives, in those communities where you've seen weakness, have you done anything else in terms of possibly maybe adjusting base prices? Or has it largely been the incentives which have helped you move product?

[Richard J. Dugas:]

It's almost exclusively around option packages that have been offered at better pricing packages. Spend $20,000 with us in options and get $5,000 off, that type of thing. Very little, if any, movement -- I don't think we've done base price changes hardly anywhere. And it's been mostly around incentives and options.

[Operator:]

Your next question comes from Nishu Sood of Deutsche Bank.

[Nishu Sood:]

About gross margins, you mentioned that the 20.9%, post interest, is the highest, I think, since 2Q of '06. In your conversation with Alan, you were describing the potential for gross margins to rise. There's obviously a big difference between a capitalized, amortized interest at this stage at 4.5% versus just over 1% back in 2006. So when you are talking about gross margins potentially rising for the next couple of quarters, are you talking about on a pre-interest or on a post-interest basis?

[Richard J. Dugas:]

Yes. Nishu, I was speaking on an adjusted basis, if you will, excluding interest. But Bob did give some commentary that we expect capitalized interest to fall as well next year.

[Nishu Sood:]

Got it. And the -- if you do that historical comparison, I believe it's even more impressive if you look at it on a pre-interest basis. So I wanted just to ask, I mean, given the circumstances we had in the beginning of the year with the tremendous price increases, and obviously, that's showing up in gross margins, but we're still at the beginning of the housing recovery, arguably, or in the early innings, call it. What is your view on what normalized gross margin should be now? And if you could frame that in terms of whether you're talking about the adjusted gross margin or the reported?

[Richard J. Dugas:]

Nishu, I appreciate the comments and the complements. It's -- frankly, it depends on what you call normalized in this industry, right? If we got anywhere back to normalized volumes, we could have some exciting numbers. Here's what I would tell you. You have to be realistic about the fact that land prices are going up, there's no question about that, which will have some diminishing or pushdown effect, if you will, on margins. Having said that, we're running a different business

[Operator:]

And this concludes the question-and-answer portion. I'll turn the call back over to the presenter for closing remarks.

[James P. Zeumer:]

Okay. I want to thank everybody for their time this morning. We'll certainly be around all day if you have any follow-up questions, and we'll look forward to speaking with you after our fourth quarter. Have a great day.

[Operator:]

And this concludes today's conference call. You may now disconnect.