Welcome to the second quarter Pulte Homes earnings conference call. (Operator Instructions) I would now like to turn the call over to Mr. Jim Zeumer, Vice President of Investor and Corporate Communications.
Good morning. This is Jim Zeumer. I want to thank you everyone for joining us on the call this morning to discuss Pulte Homes’ financial and operating results for the three months ended June 30, 2009. On the call with me to discuss these results are Richard Dugas, President and Chief Executive Officer; Steve Petruska, Executive Vice President and Chief Operating Officer; Roger Cregg, Executive Vice President and CFO, and Mike Schweninger, Vice President and Controller.
For those of you who have access to the Internet, a slide presentation is available at www.PulteInc.com will accompany this discussion. The presentation will be archived on the site for the next 30 days for those of you who want to review it at a later time.
As with prior conference calls, I want to alert everyone listening on the call and via the Internet that certain statements and comments made during the course of this call must be considered forward-looking statements as defined by the Securities and Litigation Reform Act of 1995. Pulte Homes believes such statements are based on reasonable assumptions, but there are no assurances that actual outcomes will not be materially different from those discussed today. All forward-looking statements are based on information available to the company on the date of this call and the company does not undertake any obligation to publicly update or revise any forward-looking statements as a result of new information in the future.
Participants in today's call should refer to Pulte's Annual Report on Form 10-K for the year ended December 31, 2008 and last night's press release for a detailed list of the risks and uncertainties associated with the business. As always, at the end of our prepared comments we will have time for Q&A. We will wait until then before opening the queue for questions.
Let me now turn over the call to Richard Dugas for his opening comments. Richard Dugas?
Thanks Jim and thank you to everyone joining us on the call today. Coming as we do to the end of the reporting season, I am not sure there is much new ground to cover with regard to the state of the U.S. housing industry. In fact, I see Pulte’s result as indicative of what you have heard over the past few weeks in that scattered throughout our results are a number of encouraging data points but we can fully appreciate depending on your view of the industry you can see a glass that is half full or half empty.
Sequentially our second quarter numbers show a seasonal uptick with consistent or improving results in a number of key areas. Signups for the quarter increased 11% while our community count actually fell by just over 9% relative to the first quarter. Cancellation rates were stable and backlog improved from quarter-to-quarter. We also realized positive cash flow from operations in the second quarter which is a strong performance given that it is a period in which we have historically consumed cash.
It is also encouraging to see impairments decline more than 70% from the first quarter of 2009. In combination, all these factors resulted in Pulte’s narrowing its reported loss between the first and second quarters. These results keep the company on track to again be cash flow positive for 2009 excluding any tax refunds and move Pulte one step closer to our immediate goal of returning to profitability.
Appreciating that some of the pickup was seasonal, Pulte’s second quarter results are still encouraging especially given the weak backdrop the industry experienced during the back half of 2008. Looking at the business from the first to second quarter’s there are certainly traces of stability to be found. That being said, Pulte’s year-over-year results point to an industry that still faces some serious macro headwinds including a weak economy, rising unemployment and fragile consumer confidence.
Beyond the macro issues, our operations continue to battle the global day-to-day challenges of limited buyer demand matched up against too much standing inventory and pricing distorted by foreclosed properties. The end result being key quarterly performance numbers for Pulte that are down meaningfully from the prior year.
During recent Investor presentations we have used the word choppy when talking about market conditions. From national government statistics to local results, you can find enough data points to suggest conditions may be transitioning but then you run into periods where the market hits a downdraft or the government issues poor national statistics and you are left scratching your head and questioning what is really happening in the industry.
While I am sure that everyone involved in the home building industry wants to be optimistic that conditions are stabilizing, until we see many more positive data points we at Pulte remain focused on a handful of drivers and metrics which we view as critical to maintaining and improving our business results over the near-term.
Specifically, we are preserving our balance sheet strength and flexibility. With over $1.6 billion in cash and nothing outstanding in our revolver, we are well positioned to work through these tough economic and market conditions and take advantage of opportunities when they develop.
We have to return to profitability as quickly as possible. We entered the downturn with a strong capital structure which is allowing us to weather the storm but we have to get back to making money. Achieving profitability is a goal that each of our employees understands.
Obviously the road to profitability starts with improving margins. The second quarter margins improved modestly but continue to show the negative impact excessive spec inventory can have as we close specs that we elected to sell aggressively in prior periods.
Looking to the second half of 2009 we expect margins to recover as they benefit from fewer spec closings, an emphasis on a build to order model and actions we have already taken to reduce material and labor costs. Roger and Steve will both have more on margins later.
Finally, we need to get more leverage on our SG&A. In the second quarter we reduced SG&A by $64 million relative to last year but clearly it needs to scale lower. Through the merger planning work we have identified needed actions to achieve the targeted overhead savings. Now with the transaction part of the merger coming to a close we will move quickly to implement those actions.
Having mentioned the merger let me give a quick update on how things are progressing before turning over the call. Following completion of SEC reviews, Pulte and Centex have mailed proxy materials in support of the special meetings of shareholders that each company will hold on August 18th. Anticipating a favorable outcome, we look to close the transaction promptly and then immediately transition to the work of actually merging the two companies.
Since announcing the merger four months ago, teams of functional experts from both companies have invested literally thousands of hours planning for the effective integration of organizations. We fully appreciate that successful mergers take incredible focus, effort and speed and we are working hard to make sure we achieve all of the operating and financial benefits which underpin this deal.
To ensure we can move quickly once the deal is complete, we have already identified almost the entire corporate and field organization that will run the new company. IN many ways it truly will be a new company. Within the planning process has been an exhaustive analysis of the critical business processes of both companies to help guide us in selecting the best practices regardless of the originating company. From accounting and information systems to construction and purchasing we are taking this opportunity to create an all star line up.
Having now had four additional months in which to analyze the cost saving opportunities surrounding this merger, I can tell you we are well positioned to achieve the targeted $350 million in synergies and cost savings. We have spent a lot of time detailing the savings from the corporate and field overheads estimated when the merger was announced. We continue to target approximately $100 million in corporate and an additional $150 million in field synergies. In addition, we expect to realize $100 million in annual interest savings resulting from the retirement of more than $1 billion in debt maturities. As previously announced, we expect to complete any associated actions needed to achieve these savings before year-end.
Let me just pause a second and say that while we talk about dollars and savings down the line these often represent people and we try to never forget that. These decisions have been difficult but we have been very structured and thoughtful in our selection process and have worked to treat all affected employees with respect. The professionalism displayed by everyone throughout the organization says a lot about the quality of people within the Pulte and Centex organizations.
Let me also say that the merger planning process has been extensive and has resulted in many people doing two jobs. I want to thank the leadership of both Pulte and Centex who have dedicated tremendous effort and expertise to this undertaking. Everyone recognizes the need to turn this opportunity into operating success and to create a company with unmatched capabilities.
Before turning the call over to Roger, I want to offer an additional thought about our pending merger with Centex. With a very clear vision, we can see this merger acting as an accelerant for Pulte Homes, enabling us to achieve our key objectives faster and to a greater level. From returning to profitability to driving greater operating and overhead efficiencies, to implementing a comprehensive branding strategy, the combination of Pulte with Centex will get us there faster. This is a powerful combination.
Let me now turn the call over to Roger. Roger?
Thank you Richard and good morning everyone. The second quarter home building net new order rate decreased approximately 34% from the second quarter last year and approximately 26% less communities. Revenues from home settlements from the home building operations decreased approximately 58% from the prior year quarter to approximately $654 million.
Lower revenues reflect lower unit closings that were below prior year by approximately 54%. The average sales price decreased approximately 9% versus the prior year quarter to an average of $261,000.
In the second quarter land sales generated approximately $4 million in total revenues which is a decrease of approximately $21 million versus the previous year quarter. Home building gross profits from home settlements in the quarter including home building interest expense was a loss of approximately $71 million versus a gain of $18 million in the prior year quarter.
Home building gross margins from home settlements as a percentage of revenues was a negative 10.9% compared to the positive 1.1% in the second quarter of 2008. The change in margin conversion versus the prior year is attributed to lower community valuation adjustments in the current quarter offset by reduced closing volumes and increased selling incentives.
Adjusting the current quarter for land and community valuation charges of approximately $109 million the gross margins from home settlements as a percentage of revenues was approximately 5.8% for the quarter. In addition, the gross margin for the second quarter excluding the valuation adjustments and interest expense resulted in a 9.4% conversion compared to 8.6% for the first quarter of 2009.
We expect sequential and quarterly improvements over the next several quarters in gross margins as we work our way through the backlog of higher incentives from the fourth and first quarters in addition to the house cost reduction initiatives we executed during the first quarter of 2009.
Home building interest expense decreased during the quarter to approximately $33 million versus approximately $39 million in the prior year. Included in the interest expense of $33 million is an additional $10 million of expense related to land and community valuation adjustment taken in the current quarter. Also included in the gross margin for the quarter was a charge related to land and community valuation adjustments in the amount of approximately $99 million.
For the second quarter we tested approximately 69 communities for potential impairment and valuation adjustments which were down from approximately 150 communities we tested in the first quarter of 2009. We recorded valuation adjustments on approximately 43 communities for the quarter of which approximately 32 communities or 74% had been previously impaired. Of the $99 million of land and community valuation adjustments approximately 53% or $52 million were related to Del Webb communities.
The total gross loss from land sales posted for the quarter was approximately $7.2 million. The loss is mainly attributed to the fair market value adjustment in the current quarter for land being held for disposition and land sold in the amount of approximately $7.3 million which is included in the land cost of sales.
Home building SG&A expenses as a percentage of home sales during the quarter was approximately 17.5% or $114 million, a decrease of approximately $64 million or approximately 36% versus the prior year quarter. The current quarter reflects the reduced levels of expenditures in all categories associated with the decline in volume and also included approximately $4 million in severance related to overhead reductions and merger and integration expenses.
In the home building other income and expense category for the quarter the income of approximately $5 million includes approximately $11 million related to the favorable resolution of certain matters arising from two prior land sales transactions, partially offset by a valuation adjustment in several unconsolidated joint venture investments and all of the miscellaneous operating expenses.
The home building pre-tax loss for the second quarter of approximately $187 million resulted in a pre-tax margin of approximately negative 28.5% on total home building revenues. Excluding the land charges related to the valuation adjustments and land inventory and investments, land held for sale, severance and related charges and the merger and integration expenses, home building pre-tax margin converted at approximately a negative 9.7% from operations or approximately $64 million loss for the current quarter.
The pre-tax loss from Pulte’s financial services operation for the second quarter was approximately $9.4 million or a decrease compared to the previous year’s quarter of approximately $20 million. The loss in the quarter is mainly attributed to the 54% reduction in loan origination principle volume from reduced settlements and in addition, we increased our loan loss reserves by approximately $16 million in the quarter related to foreclosed properties and losses on loans held for investment, repurchase or reinsured.
The product mix in the second quarter for funded agency originations were approximately 99.7% of loans funded from the financing line versus 98.6% for the same period last year. Non-agency funded originations fell from 1.4% of loans funded from the financing line last year to less than 1% this quarter. Additionally, within the funded agency originations FHA loans were approximately 34% of the loans funded from the financing line in the second quarter compared to approximately 30% in the first quarter of 2009.
The level of adjustable rate mortgage products originated during the second quarter of 2009 decreased from approximately 3% of origination dollars funded from the line in the second quarter to the previous year 0.1% this quarter. Pulte Mortgage’s capture rate for the current quarter was approximately 91%. Mortgage origination dollars decreased in the quarter approximately $472 million or 54% compared to the same period last year. The decrease is related to the volume decrease and the home builder closing activity for the quarter.
The average FICO scores of our loans closed for the period was 752, increasing over the 744 score for the first quarter of 2009 and up from the 736 number from the same period last year.
In the other non-operating category, pre-tax income for the second quarter of approximately $10 million includes corporate expenses of approximately $8 million offset by $2 million in net interest income related to the invested cash balance during the quarter. In addition, we realized a gain of approximately $16 million on the repurchase of debt during the quarter representing approximately $193 million at face value.
For the second quarter the company’s pre-tax loss was approximately $187 million. Excluding the charges related to the valuation adjustments and land inventory investments, land held for sale, severance and related charges and the merger and integration expenses and the gain on repurchased debt, we had a pre-tax loss from operations of approximately $79 million for the company in the current quarter.
The net loss for the second quarter was approximately $189 million or a loss of $0.74 per share as compared to a net loss of $158 million or a loss of $0.63 per share for the same period last year. The second quarter of 2008 reflected a tax benefit of approximately $57 million primarily due to an adjustment in the deferred income tax assets. The number of shares used in the earnings per share calculation was approximately 254.8 million shares for the second quarter of 2009.
Reviewing the balance sheet for the quarter, we ended with a cash balance of approximately $1.64 billion, decreasing approximately $110 million from the first quarter of 2009. House and land inventory ended the quarter at approximately $3.7 billion. Excluding the inventory valuation adjustments for the second quarter of approximately $109 million, total inventory decreased approximately $68 million from the first quarter. House inventory excluding land for the quarter decreased approximately $95 million. Land inventory during the second quarter excluding valuation adjustments increased approximately $27 million from the first quarter.
The major changes in land inventory from the first quarter were from land released from home settlements of approximately $166 million, offset by investments in rolling lot option take downs and purchases of approximately $29 million, land development spending of approximately $119 million during the quarter and an increase in capitalized interest and reclassifications from land held for sale totaling approximately $45 million.
In accordance with FAS 109, accounting for income taxes, at June 30 we had net deferred tax assets of approximately $1.3 billion which were offset by a full valuation allowance due to the uncertainty of realizing these deferred tax assets.
The major components of the net cash used for the quarter of approximately $110 million resulted from the decrease in inventory contributing approximately $68 million to the reduction of house inventory offset by a slight increase in land inventory. Also during the second quarter we took advantage of the opportunity to repurchase $193 million of principle senior notes for $176 million in cash. This is in line with our stated goal as announced with the merger of Centex which is to retire in excess of $1 billion of debt prior to the end of 2009.
With approximately $1.64 billion in cash to end the second quarter, we had no outstanding balance drawn on our revolving credit facility at the end of the quarter. The company’s gross debt to total capitalization ratio was approximately 58% and on a net basis 38.4%. Interest incurred amounted to approximately $53 million in the second quarter compared to $57 million for the same period last year. Pulte Homes’ shareholders equity for the second quarter was approximately $2.1 billion. We repurchased no shares during the quarter and the company has approximately $102 million remaining on our current authorization.
On our financial covenants for the second quarter the required debt to capitalization ratio was not to exceed 55%. At June 30th the ratio as defined in the credit facility was 53.3%. The tangible net worth cushion as defined in the credit agreement was approximately $41 million. In addition, at June 30 we were in compliance with all of the covenants under the credit facility.
I will now turn the call over to Steve for additional comments on the quarter. Steve?
Thanks Roger and good morning everyone. In thinking about the second quarter and the first six months of 2009 what may be more telling than any of the specific numbers is the overall sense of stability as we move through the weeks and months. Certainly we continue to experience market swings and shifts in industry conditions but relative to the incredible volatility the industry has experienced over the past couple of years the moves have been muted. In a word I would say business has been consistent in the past few months.
Within this environment we are operating against a very narrow agenda that supports the immediate goals of conserving cash and returning the business to profitability. To that end we continue to maintain very tight controls over our house inventory as we work towards more of a build to order model. At quarter end Pulte’s speculative home inventory stood at approximately 1,800 units which was down 24% from the end of the first quarter 2009 and down over 40% from the same period last year.
Of these homes, less than 800 were finished specs which was a drop of 40% from the end of the first quarter. Of the remaining specs most are sitting at the start stage and even within that number a high percentage represents attached product we are building. Just pouring the foundation can add 40-50 units to our spec inventory.
As discussed earlier, having some specs can be helpful in attracting certain types of buyers but having too many in the pipeline in any given community is a recipe for margin pressure and we saw that again in Q2 as we closed a number of spec homes. \The teams have done a good job selling through the specs during the first six months of this year and have maintained discipline with regard to not starting additional units during the quarter. By lowering our inventory we reduced cash invested in the business and we ease some of the pressure on margins. When combined with other initiatives to reduce material and labor costs, we can see our way towards improved results as aggregate margins per houses in backlog have trended higher.
Consistent with my comments during our Q1 call we expect the benefit of our actions will have a more meaningful impact on reported margins in the latter half of 2009. Although not factored into the $350 million in synergies Richard discussed, combining the Centex volumes with ours provides the opportunity to combine purchasing and production efficiency to another level.
Along with our material and labor costs we continue to make progress aligning overheads with current volumes. We did some good work in Q2 but now with the merger closing date approaching we can and will do more. Obviously in markets where Pulte and Centex have overlapping operations we can quickly combine the two field offices. This opportunity exists in roughly 85% of our markets which is a big piece of the $150 million of deal synergies we have estimated in bringing together our two organizations.
We fully appreciate that our actions will impact people’s lives so we don’t take any of this lightly but we also understand we will need to move quickly to implement changes once the merger closes. Our goal is to achieve profitability as quickly as possible. In light of market conditions we are also being very careful in managing our lot inventory. Pulte had less than 119,000 lots under control at the end of our 2009 second quarter, a 12% reduction compared with our prior year second quarter.
Of these total lots, approximately 97,000 were owned and approximately 22,000 were controlled with options. We are maintaining tight controls on our investments in land and related development but we are starting to see select asset efficient deals that make financial sense. Though each deal is different, the typical project profile is smaller in size, finished lots, option take downs, and quick turning opportunities with limited capital outlay.
As an example, two weeks ago we were able to secure an opportunistic deal in Tucson which allowed us to get the Del Webb name back into that market with a roughly 500 home community. As we move forward there will be more and more opportunities for us to purchases these types of asset efficient projects and effectively blend them into Pulte’s overall portfolio.
In another sign that conditions are becoming more stable the cancellation rate for the quarter was approximately 22%. This rate was essentially unchanged from Q1 of this year while showing dramatic improvement over the same period of 2008. Within this metric our Del Webb communities continue to perform slightly better than our traditional projects with the cancellation rate running just over 19%. Clearly we are seeing more people get comfortable buying a home as net signups for the quarter were just under 3,400 homes which represents an increase from Q1 of 11% or more than 300 houses although this was a year-over-year decrease of 34% from Q2 2008.
It is worth noting that the sequential increase in signups was generated from a community count of 497 which was down 9% from the first quarter and down over 26% from last year.
Drilling down into Pulte’s operating areas; we realized improve sign ups in the Atlantic Coast which was up 21% from the first quarter 2009. Strong quarter-to-quarter increases in Raleigh, Georgia and the mid-Atlantic drove the improved 2Q results. Our Gulf Coast operations also experienced a nice increase in signups for the quarter, adding 15% from Q1. Q2 results for Florida were flat with the first quarter while our Texas markets showed significant gains in signups relative to the first quarter.
In the southwest we realized a similar improvement in business as sign ups from the quarter grew 12% from Q1 of this year. It was encouraging to see our Las Vegas business pick up with sign ups increased by more than 36% relative to Q1 while our Arizona and New Mexico operations delivered stable to slightly up numbers in the quarter compared to Q1.
Out west, our California business in the quarter was essentially unchanged from Q1 as modest gains in Northern California were offset by lower sign ups in the markets in the southern part of the state. Finally, Pulte’s Great Lake operations continued to face the most difficult demand conditions as the Midwest states struggle with a very weak economic condition and ongoing uncertainty of the health and future of the auto industry. For the quarter, sign ups in the Great Lakes decreased 2% from Q1 2009.
I am encouraged with our second quarter results and the trends we have seen through the first half of 2009. Of course, we would have liked to have seen more sign ups but as I said at the outset, I think the quarter was noteworthy more in its consistency than total volume. Traffic, sign ups and cancelation rates were steady throughout the quarter. Given the volatility we have experienced in the past couple of years, the second quarter and the first half of 2009 feel a little more stable and stability must occur before we see improvement.
I will turn the call back over to Jim for Q&A.
Thanks Steve. We will now open the call to questions. As we have done in prior calls, we will keep it to one question and one follow-up. If you have additional questions please feel free to get back in the queue or you can follow up with us directly.
Operator, if you would please give any needed directions, we will now open the call to questions.
(Operator Instructions) The first question comes from the line of Michael Rehaut – JPMorgan.
Michael Rehaut - JPMorgan
My first question focuses around the sales pace. We are all glad to see the improvement sequentially and certainly the return of a seasonal pattern is encouraging. On a year-over-year basis the absorption was down 12% by the numbers. This is in contrast to some of the other builders that have reported so far that have seen a year-over-year increase in absorption. Is it possible, obviously you have your own business and you can’t necessarily fully comment on maybe what the differences are, but to your extent or the extent possible, what do you think the state of the industry is in terms of the improvement in tone and trends and also I guess any comments on perhaps why the absorption pace hasn’t picked up more strongly for Pulte versus some of the other builders out there?
I would say the results we are experiencing are very similar to what others are experiencing. When you go back and look at quarter-over-quarter results from a year ago, a lot of things factor in. We may have had a big sales event. Someone else may have had a weak quarter or a strong quarter. So frankly, I think the much more relevant thing right now is are we seeing improved business from what was a horrendous fourth quarter of last year. That is why we are discussing more of the sequential improvement. It seems to be one of stability. I think if we go back on our own results since January or February we have had a very consistent sign up base. Candidly I would tell you we are not displeased with our overall sign up base. Obviously we would like to see more margin. We talked about moving more towards a build to order model and looking for better margins later in the year but frankly the sales pace as you look at it on a year-over-year basis is influenced by a number of factors and relative to what others are posting we are not disappointed with our sales pace. It is more about getting back to profitability.
Michael Rehaut - JPMorgan
A follow-up, you mentioned traffic and orders and can rates were steady throughout the quarter. I was wondering if you could talk about if that also applied to pricing trends. In terms of pricing how do you feel, we have been through a period the last 12-18 months on a national basis down 1-2% sequentially month-to-month? The data has shown that has moderated a bit. Have you seen that in any of your markets? On a regional basis if you could talk about perhaps where pricing you have observed is more stabilized over the last few months? By contrast where it is still slipping month-to-month?
I will give some general comments and then turn it to Steve for more specifics. In general pricing was a lot more stable this past quarter than we had seen particularly last year. Frankly it was encouraging coming off a relatively stable first quarter. I would say it was more stable in Q2. We actually had a couple of markets where we have been able to raise price in very modest amounts. Having said that in some markets we are being pressured by appraisals which is bringing pricing down relative to what we sold the homes for.
I think the watch word is much more stable. I think you saw that in the impairment numbers came down dramatically from over $400 million in Q1 to a little over $100 million in Q2. That is just a general comment. Steve?
Richard’s comments are spot on. It was much more stable. Obviously there are some markets out there where we have more speculative inventory where we may have discounted a little bit to get through that inventory so it was kind of a self-implied pressure. On an overall basis we are seeing stability across the board. Probably still softest where you would expect it softest which would be the southwest markets, some southern California stuff although not nearly as bad there and then certainly Florida as we move through the inventory there.
On an overall basis, both sequentially from the first quarter and then if you look back into the fourth quarter of last year through a combination of that pricing stability and in the movements we have made to take some costs out of it we are seeing both margins on spec sales and margins on dirt sales starting to move in the right direction.
The next question comes from the line of Daniel Oppenheim - Credit Suisse.
Daniel Oppenheim - Credit Suisse
I was wondering if you could talk about your goals in spec, getting down to 1,800 is certainly a big improvement with 800 finished and looking at fewer than two per community for finished specs. What are the goals and are there any areas where you are out of line with what is sort of the overall company [inaudible]?
In this environment we see limited opportunity for spec inventory to make much of a positive difference so our goals are to get substantially lower from here. There is a big difference in margins we are experiencing on spec units versus pre-sold units not accounting for what might happen at the appraisal line at closing. Our view is to drive it lower. Realistically with the attach product that Steve spoke about it is hard to get it to zero but our goal is to bring it meaningfully lower.
Not all specs are created equal. The finished spec inventory is what we continue to stay most focused on. I would tell you our operators would speak to on a per community basis not trying to have any more than one per community on an average being a very worthy goal. As you look at the community count right around 500 that would tell you we are still sequentially about 300 more specs in a finished state than what we would like to have on an average basis but clearly that varies from community to community across the country. The overall goal is to continue to drive it as low as possible and focus on the dirt sales out in front of you and the positive things around process to drive cycle times and delivering those dirt sales that we know committed higher margins.
Daniel Oppenheim - Credit Suisse
Also in terms of you mentioned appraisals a couple of times where are you seeing the most issues with that? Is it the higher end homes you are selling? Can you quantify that in terms of percentage of homes where you are having issues in terms of appraisals?
As a percentage of overall I couldn’t quantify that for you. We could probably dig up some data but what I would tell you is that it is across the board. There is stability at the low end so yes where we get into some of that first move up buyer where there is a lot of foreclosed inventory and first move up homes that are coming back on the market we are seeing a lot more pressure. Again, specifically in the markets you would expect; Phoenix, Arizona, Las Vegas, Nevada, the Inland Empire of California, some northern California markets outside of the South Bay and certainly the South Florida markets.
The next question comes from the line of Ivy Zelman – Zelman & Associates.
Ivy Zelman – Zelman & Associates
I apologize if you have given this already but I don’t think you did give specifically what the total lot count under control at 119,000. Could you tell us what you anticipate for this year what your total land spend would be?
We are still looking at around $600-650 million in total investment in land development. Around that outlook we are looking roughly at about $150 million in rolling lot option take down’s throughout the year as well. We are still in a range we have been talking about for the first half of this year.
Ivy Zelman – Zelman & Associates
With respect to that just generally we see a lot of activity that is starting to come to fruition with respect to land deals. You mentioned the small, more efficient projects with all of the land I’m not sure what percent of the 97,000 that is owned with the break down that you provided, how much is undeveloped. One of the questions all analysts ask are why are builders trying to buy land when they have so much ground already? We understand why and obviously you want to get a better return on distressed land. I think one of the things at least you described in your comments as it related to the merger with Centex, you were going to have a lot more finished lots available and some of the conundrum that the industry faces today is that people just don’t have enough finished lots. They are maybe now chasing deals because they are running out of land. I am just curious from the 30,000 foot view and your position what is really going on out there? Is it builders running out of desirable finished lots? Are people going to have to start developing ground, which means utilizing cash and actually possibly even being impaired before you get started if we don’t see any major improvement in pricing? If you could give us your perspective I think a lot of people would find it helpful.
First of all, builders are running out of good lots. I think a lot of builders have plenty of lots that are maybe not in locations they want but in terms of the inventory that people really want to sell builders are running out. That is why you are seeing a lot of activity out there and a lot of people expressing interest in land.
One of the frankly opportunities we see from the Centex combination is they have frankly excellent lots in excellent locations in consumer groups that are attractive to us right now. We mentioned before the Texas locations and the coastal Carolina locations that for Pulte are dominated by Del Webb and frankly we have the opportunity to pick up inventory there that is not only appropriately focused on the buyer group but also finished so we don’t have to put a lot of capital into it.
We are very excited about the opportunity on land as it relates to Centex. As you can see they have impaired their assets appropriately and Pulte has impaired its assets appropriately so we feel good about our underlying inventory. Any of the deals we are seeing outside of that are small, frankly, opportunistic and we are in a position where we can utilize some of the cash that we have to pick up inventory where we need it and where it makes sense for us. But it is on a select basis and it is in markets that we feel good about. We have an allocation by market and frankly there are several markets that we wouldn’t invest in right now but there are others that we are excited to. Steve I don’t know if you want to provide any more granularity on land beyond that.
On an overall basis what is coming out of the activity is clearly because people need the lots. The sales that have occurred over the past 12-18 months have been out of your better communities. Therefore what you are left with is the communities that quite frankly aren’t performing as well. Builders are seeing the opportunity to on a very select basis pick up some improved lots that we still value at a below cost basis. In other words if we were to go out and even on impaired land try to develop those lots what we are seeing come out is cheaper than what it would cost to finish even in today’s environment.
Those are very selected. Very few and far between. We have diligently gone through those with our operators and as Richard said where necessary and where opportunistic we can do it we feel free to invest a little bit of cash to get those deals done. Clearly our opportunity lay in the acquisition and merger with Centex and the acquisition of their finished lots at the right basis and the right price.
The next question comes from the line of Nishu Sood – Deutsche Bank.
Nishu Sood – Deutsche Bank
I wanted to follow-up on Dan’s question earlier on specs. So far this year, I think particularly this quarter, you have seen builders shift to more of a spec build model. I am talking beyond the regular debate that rages every quarter of should we building specs or not. Many are seeing some builders that have been strictly dirt sales in the past putting some more spec to respond to the current demand conditions. It doesn’t sound like you have made a similar philosophical decision this quarter or so far this spring selling season. I just wanted to understand the differences in what you are seeing because the order performance that you have this quarter might argue that some more specs have been on purpose. I just wanted to get some more color on your thoughts on that.
The goal is profitability, not units. Frankly even one of our large competitors that reported today indicated a substantial operating loss on almost 2,000 additional closings from what we had. Specs are not a given in terms of profitability. We have seen a substantial difference in margin between pre-sold units and focusing our organization on selling strength and inventory of lot inventory with homes on it versus spec inventory. You are right. There has been a little bit of a difference in our focus from what you have heard from a couple of other competitors. Steve do you want to add to that?
That will continue to be our focus. To Richard’s point, the margin improvement on a dirt sale relative to a spec sale is significant. We are seeing plenty of activity in our ability to continue to sell dirt. We get in a better position every quarter. We were caught very short in the fourth quarter of last year but that contributed to our problems throughout the first quarter. As we aggressively go after house costs we can price those to be built homes at a very competitive price relative to any spec sales out there. We are not predominately in the first home business and I know with government incentives running out that has been a significant driver behind some builders putting specs out there. That is quite frankly not our business currently. We will get into that more with the Centex opportunity. Staying focused on a build to order model and staying focused on the operational efficiencies to be able to turn those houses quickly, we believe we can deliver a better alternative for consumers wanting to get into the new home market at much higher margins.
One more comment, the goal is again profitability; not size and not unit volume. We intend to be very focused on overhead as we have been to appropriately size our organization for what size business we have. Our view is profitability over size every day.
Nishu Sood – Deutsche Bank
I wanted to ask on your debt repurchases, $180 million you put towards debt repurchase this quarter. With the merger you had set a target of I think $1 billion of debt reduction. I was just wondering if you could maybe put that in context. Is the debt reduction going to come mostly from the Centex side versus the Pulte side? Just if you could put this quarter’s debt in context of the overall total?
I think what we have stated since the opening of the merger was to retire basically in excess of $1 billion. So we didn’t specifically say how much. This is very much in line with our goals. Naturally when you are looking at the size of that we are trying to get short-term maturities but you have to look at the overall maturity schedule you have. Both Centex and Pulte have put us in a very good position going forward. So, we will likely do some of each but to be more specific now I can’t at this point.
The next question comes from the line of Ken Weiner – MacQuarie Capital.
Ken Weiner – MacQuarie Capital
Can you highlight the units under construction the percent of closings that were spec and the margin spreads you faced on those specs?
Our difference between what we are selling as spec or even what we closed at spec and dirt, as we call it, roughly has been running around 600 basis points. As Richard mentioned earlier, when you are dealing with spec and you have to give up 600 basis points from the dirt sale, again that can be pretty significant. Typically last year, of our closings, we were running around roughly around 2/3 of our closings were from spec. If you had a lot of the cancellations come through. We saw that number spike up in the fourth quarter and first quarter and second quarter as we were driving to lower our specs overall.
We were roughly probably in the 80% of our closings in the second quarter that were spec. Again, it is very difficult to track those but again, a dirt sale at one point that cancelled and then we are going to call that a spec. As your work through the quarter or many quarters, two quarters for instance, until you get a closing that is how we refer to those numbers. It could easily have been a started spec, a foundation or it could have been a sale that turned into a spec. So that is [helping] the numbers at that point.
Ken Weiner – MacQuarie Capital
The unit under construction was what?
The units under construction at the end of the quarter was approximately 4,500.
Ken Weiner – MacQuarie Capital
I realize you are focused on profitability which is good because that is what shareholders get, but could you talk about perhaps the long-term implications of the builders that are focused on profitability and in your case that would imply lower base of units as the cycle recovers versus a builder that is perhaps more focused on specs given that the higher volume, i.e. higher market share, will reside with the spec builder. Can you talk about concerns you might have about that? If you don’t have any because profitability is the key metric?
I don’t have any concern with that frankly. We still have most of our communities active. We have not shut down a huge percentage of our communities. When business does improve, and frankly we intend to help it improve by not giving away product and building for practice, we will have strength in those existing communities and when business does improve it is same store sales that are going to see the improvement first. Where you don’t have excess spec inventory begging for a discount you are going to see improved margins and frankly improved profitability. There are a couple of builders in this space that have shown that is a very attractive model. Good market or bad market. So I am not worried about that.
From a market share perspective, we will certainly have our fair share of share. Not to use the share word too many times there. As a builder with a lot of active communities particularly with the pending merger with Centex, I am not concerned about market share. We have a lot of scale in local markets. We have purchasing initiatives that are very aggressive. Steve mentioned those have not been factored into our overall savings equations with the merger. That will be on top of everything we talked about. I don’t think that is a good reason to build units in a tough environment only to have to discount them later.
The next question comes from the line of Joshua Levin - Citi Investment Research.
Joshua Levin - Citi Investment Research
Maybe you could tell us how the trend in sales and closing volumes in the Del Webb business has compared to your non Del Webb business?
Anecdotally, as Mike has the statistics here. Maybe he can give you the actual sign up numbers, but on an overall basis we continue to see great traffic numbers in the Del Webb buyer profile. So we are getting them out to the community. The decision making process is taking a little bit longer as they wrestle with certainly loss of equity in their home. Although we have gotten them over pretty much that equity exchange because our prices are down significantly from when the first time they moved to the product. The conversion rates are still down mostly based on their whole concept of financing or finances available for retirement. We have seen our conversion rates drop even though our traffic has maintained a relatively flat number.
We view that as good. The buyer is clearly a discretionary buyer but the trends have been relatively flat to slightly down on a per community basis. We think that again we are building some pent up demand out there relative to traffic levels. We are optimistic that as things start to improve and we see some continued recovery in the economy that is very, very good for the active adult buyer segment.
Just so you know, for Del Webb, one third of our signups for the quarter at 1,067.
Joshua Levin - Citi Investment Research
I guess about two months ago you filed the S4 and in the S4 you gave some projections about how you thought you would adjust Centex’s balance sheet when the deal closes. Obviously you have to factor in Centex’s results since that happened but are you still comfortable with those projections?
Yes we are very comfortable with what we looked at. Again, we mentioned then and numerous times after that we weren’t looking for the market to begin to pick up. We were actually planning through 2010 to be another down year relative to where we were. Not a lot has changed from that perspective. We are going to wait and see how the market begins to change. If it does out in front of here, but looking at the things we looked at then we still feel very comfortable about the transaction overall.
The next question comes from the line of Megan McGrath – Barclays Capital.
Megan McGrath – Barclays Capital
You mentioned the fact that prices have stabilized somewhat during the quarter. Just curious, looking forward assuming we continue to see some stabilization, how should we think about in your view the interplay between prices and incentives? Should we see prices go up first? Incentives come down first? What should that mean in terms of what we will see on the margins?
We have gone to a more transparent pricing model like a number of folks have. I suspect it will be a bit of both with probably incentives coming down first and then seeing kind of base price stability there. That would be what I would say. Again, the markets are going to recover at different points in time. You have one or two markets that are showing some strength. For example, Washington D.C. with all the federal spending that market is benefiting frankly from more home buying activity so we are able to even get a few price increases there. I would suspect it is probably the incentives coming down first with the base price second. Steve I don’t know if you have anything additional?
We are so focused on cost decrease, sometimes we are doing cost decrease to get back down to a fair market price. With cost decrease at 6-7% of the house cost and maybe margin improvement of maybe 1-2% because you are still reducing your base price by 5% to compete with foreclosures or other builders that are building specs. You have got to really kind of watch what you are looking at out there from a numbers standpoint because clearly the markets have readjusted. There is a lower pricing model that is attractive to buyers out there today. The psyche of buyers is they still believe it is time to get a deal in housing so your incentives play a little bit to that. Our focus isn’t necessarily on the base price and/or the incentive, it is on improving the margin on an overall basis at absorption rates that are acceptable and level to our overhead necessary to manage that absorption. So, it is a tricky question. I think you see, like Richard said, a little bit of everything going on in there.
Megan McGrath – Barclays Capital
On the margin, to get a little bit more color, I think you said last quarter if I remember correctly that you were looking for gross margins to be up potentially 50% from the prior quarter. It looks like they maybe came in a little below your expectations. I’m just curious, did you sell more specs than you expected? Did you lower the prices a little bit more versus your expectations? What were the things behind the gross margin this quarter?
I think when we were having the conversation last quarter I was referring to out in front of us, not specifically the second quarter. I will address the second quarter as well. As we are looking out we are seeing our projections and backlog were increasing. Not that they were all going to get delivered in the same quarter quite frankly. 50% would still be accurate based on the last quarters of you have taken out the impairments. We are still seeing improvement in the margin going forward over the next four quarters as well.
Looking out into the back end of the year as a Pulte stand alone business we are seeing margins increasing roughly 50%. In the second quarter specifically if you look at it really we did sell or close more specs in the quarter which also pressured that a little bit more. We also had our vertically integrated operation in the southwest where we actually elected to take a little bit more cost through the margin side versus what we have been doing in the previous quarters because of the absorption rate we are experiencing there.
We roughly have about another $4 million drawn through the margin which cost us roughly about 60 basis points more in the quarter just because of the level of activity. We constrained the operation there and then elected to take more costs directly instead of going through inventory. That also impacted it in the second quarter.
The next question comes from the line of Jay McCanless – FTN Equity.
Jay McCanless – FTN Equity
I wanted to stay on the segmenting of the markets. If you exclude the active adult communities and you look at your entry level versus move up communities, which one performed better in the quarter versus last year?
We don’t break it out in that much detail other than the Del Webb versus traditional. I would tell you anecdotally the first time buyer segment is probably the best performing given the $8,000 tax credit for a first time buyer. The California tax credit which of course is now out of money would help that as well. The anecdotal evidence we are seeing from other builders and some of our peers around the system.
Pulte, as you know, independent of Centex, does not have a huge percentage of our business focused there which clearly is attractive to us to have a more balanced portfolio pro forma after the closing with a significant portion of Centex’s business not only focused on the entry level buyer but also in markets where they have a good position such as Texas that we talked about before.
Jay McCanless – FTN Equity
Is there anything in the early trends for 3Q that would make you think move up might be performing a little bit better than you had expected?
We really aren’t commenting on Q3. I would say kind of steady as she goes so to speak relative to the markets. Haven’t seen big movements one way or another.
The next question comes from the line of Eric Landry – Morningstar.
Eric Landry – Morningstar
Could you outline the geography of the $119 million in charges?
Just take a look at the P&L, the impairments that went to cost of sales was roughly $109 million and the land was about $7.3 million. Those would have been the net realizable value adjustments. Very little on the pre-[aq] was about roughly $300,000 for the quarter.
Eric Landry – Morningstar
You mentioned that dirt starts were roughly 600 basis points higher in margin than the spec. Is that correct?
Yes, those were for homes that closed in the quarter that were either pre-sold or spec that closed in that category. Yes.
Eric Landry – Morningstar
If I can do some quick math it is still significantly below where the SG&A stands right now. If you would could you sort of give us your thinking as to how you are going to get that rate over somewhere around the SG&A rate in the next period of time?
For instance, just coming out of what we talked about in the last couple of quarters was reducing the spec. So if you had the spec you had to move it. So that put more pressure on the margin because we wanted to sell them and convert them to cash. What we are seeing now relative if you look at our sign ups in the current quarter roughly 50% of them would have been spec in the second quarter. Relative to what we closed in the quarter it was 80%. If you look at the margins at roughly a 650 basis point swing, what you are doing is swinging from the spec which is depressing the margin to actually moving over to sales that increase the margin. So as we are looking out forward as I mentioned, just because of that we are beginning to see the expansion of the margins going forward over the third and fourth quarter and the balance of this year that we haven’t seen in the backlog.
Additional to that, we talked about the cost impacts we were trying to drive in the first quarter. Of course they are going to come through not in closings in the second quarter because homes were already under construction at that point, but pretty much through the third and fourth quarter we will see the bigger impact in that. So, that is why we felt pretty comfortable of watching that margin expansion going forward into the back end of the year. So that is what we are looking at today to see ourselves get back to profitability as we move away from specs overall.
The next question comes from the line of David Goldberg – UBS.
David Goldberg - UBS
My first question kind of relates back to an earlier question on appraisal. I know you can’t give the breakdown on the issues you had on your home specs under appraisal levels. I kind of wanted to address this a different way. That is to say instead where you are having issues with appraisals, how frequently are you cutting the price so you can get the appraisal amount versus taking the home back in inventory and maybe bringing it back in the market. I’m just trying to get an idea of how you think about that decision making process and how your operators are going about that.
That is a good question and I can tell you we have a very specific process for it. Clearly what we do in most appraisals is we will challenge it. If it is significantly below, and significant means by a couple of hundred bips on the margin, if it is really hurting the operation we challenge. The way the mechanics work is you cannot challenge the appraisal until the home is final and completed. So even on a dirt sale if you have an appraisal problem you have to wait until the home is final before you can challenge that appraisal. I would tell you clearly in 90% plus of the cases we are challenging the appraisal. Exactly to your point most of our communities are fairly large scale. We don’t want to hurt our own comps in those communities as we move forward. It just is kind of a recipe for disaster if you just take the appraisers price and run with it to the mortgage company and sell the house and discount it at that price.
So we go back and challenge in almost 90% of the instances. I would tell you probably 75-80% of those 90% instances we get some increase in value on the challenged appraisal. That is going to continue to be our process. It slows things down, maybe to the tune of 30 to sometimes even 45 days as we go through this challenge process but we think it is appropriately the right thing to do. It continues to support our ability to maintain pricing on the dirt sales. I think it is the right thing to do for consumers that are in those communities and buying those communities. It is just kind of a matter of course and something we will continue to do is challenge those appraisals.
David Goldberg - UBS
My second question is on the cost savings, specifically the cost savings in the field from the Centex acquisition. I am just trying to get an idea of how sensitive the projected amounts are to changes in volume and whether you think the volumes in terms of units are kind of meeting your expectations, exceeding your expectations as you look at Centex’s performance and the combined company’s performance as we head through the year. Do you think there is maybe more synergy than without? Less synergy? Based on kind of a unit sensitivity analysis?
The numbers we outlined are not real volume dependent. Having said that, the performance we are seeing out of the Centex business is very consistent with what we saw through due diligence and have had visibility to as we have worked on the merger integration. So, we feel very good about the numbers we have provided. Really don’t want to comment a lot beyond that other than to say that anything on the procurement side as we talked about were not factored in there. Frankly, we are working and expect to work hard on those numbers. We expect to get the $350 million in annualized savings and then whatever else we can provide. So we feel real good about those. Having said that, the volume we are seeing and the level of business is about at expectation.
The next question comes from the line of Carl Reichardt – Wells Fargo Securities.
Carl Reichardt – Wells Fargo Securities
You mentioned community count down 26% year-over-year. What is the Webb count down versus the traditional Pulte community count down year-over-year?
Perhaps we could do a little more digging and get back to you. We don’t have that at our fingertips.
Carl Reichardt – Wells Fargo Securities
Recognizing one of the reasons to purchase Centex is the relative flexibility in their lots. Is your expectation that after the merger we might see an increase in land sales as you work through markets you might want to pare back on? How should we think about how you will de-asset the company if there is going to be any de-asseting?
I don’t think there is going to be any de-asseting. Frankly from an equity standpoint it is Pulte’s equity acquiring these lots. We still have cash available for opportunistic purchases should we see them elsewhere. Our intention is not to bulk sale anything or get out of cities or strategically go after things. In our analysis there are precious few head-to-head competition between Pulte and Centex in the market given their strategic fit at the entry level and first move up with our predominance in active adult. Save a few isolated communities where we are head to head, and there might be a handful of those, I don’t see any real movement of assets there.
The next question comes from the line of Alex Barron – Agency Trading Group.
Alex Barron – Agency Trading Group
I was wondering if you have the number for benefit to gross margin from previous impairments this quarter.
Those numbers are almost getting somewhat meaningless as we look over time here but we probably had around $80 million write down there that would have contributed in the second quarter.
Alex Barron – Agency Trading Group
My other question was with regard to Centex, have you already completed kind of an analysis of what their land basis is going to be on your books to determine if you are going to have goodwill or is that something that gets done after you close the transaction?
Yes, that is all done at the close. You would look at what that value is at that time. We tried to outline what we had in the S4 at a couple of points in time. That was directional. Certainly a lot of things have changed in the seven months in their business and in our business but directionally we try to list what we were seeing at that point in time and update it along the way as well with our next filing of the S4. Again, there will be goodwill associated with it but all that is dependent upon the stock price, the valuation and what we see as movement in the market place overall for the fair value of the assets themselves and the liabilities.
The next question comes from the line of Jim Wolfen – JMP Securities.
Jim Wolfen – JMP Securities
I was wondering if you could give a little bit more detail, I know you gave the Dell Webb percentage on impairments, maybe a little bit more detail on other geographies? Any thoughts on sort of where we stand or how close to being done any of those parts of the country might be in your view?
I would say it was all over the country. We looked at a lot of our markets. We had in the Gulf Coast area, the southwest and California. It was pretty much spread around. It wasn’t any huge concentration in any one area. I think what we found again with the Dell Webb product this quarter again the pressure from foreclosures in some of the markets, the pricing and the pace. We ended up going back and making some more adjustments on that. Overall, I would say that wasn’t concentrated in one specific area.
Jim Wolfen – JMP Securities
Any thoughts for where you stand now on impairments and what the future might hold?
You come through every quarter but the good news about this quarter which we have seen differently from other quarters is a stabilization in pricing. Not to say that again pace won’t change that in the future or some different outlook but I think as pricing gets stable it gives you a view of the pace and becomes stable as well. All those things could start to indicate an end to it. I don’t think we want to predict that. Just looking again at what you are seeing in stability gives us a better hope that potentially we are coming down towards the end of this.
The next question comes from the line of Buck Horn – Raymond James.
Buck Horn – Raymond James
I was wondering if you could be a little bit more specific about Centex and the potential impairments on closing. I was just going through the prospectus again. For the numbers you had in there, it looks like $610 million was expected to be written off of Centex’s inventory as of March. Of course if you look at just what they reported in terms of impairments for this quarter does that infer there would be about $400 million of write off’s yet to be taken when you close the deal?
Yes, if all assumptions were the same assets directionally that is correct. Again, there are nuances in there as you start going through it and assumptions and changes like that as you look at each one of the models. So technically you would have to go back and fair value every asset. Again, the impairments would be fair value. So yes, directionally you are correct.
Buck Horn – Raymond James
But there could be a little bit in excess of $400 million where it sounds like it is headed?
Again you have to go through and do each one. Some move differently than others each time you do it. We have to get a look at it on the closing date and recalibrate ourselves at that point. It could be more. It could be less. It is just going to depend on what each specific asset is doing over this period relative to taking a macro approach to it.
I would now like to turn the call back over to Richard Dugas for any closing remarks.
Thank you. Having reached the midway point of 2009 I am confident in Pulte’s overall financial strength and market position. While I am pleased with the strides we have taken, I know we have hard work in front of us to regain profitability and begin moving the company forward. We would expect on our next quarterly call we would be discussing integration progress following completion of our merger with Centex. Over the near-term this merger affords Pulte hundreds of millions of dollars in cost savings that no other competitor can achieve going it alone.
Longer-term integrating Centex can accelerate and amplify our ability to implement core business strategies and drive improvement in our operating and financial results. Thank you for your time this morning. Have an excellent day everyone.
Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Have a great day.
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