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PulteGroup, Inc. (NYSE:PHM)

Q1 2014 Earnings Conference Call

April 24, 2014, 08:30 AM ET

Executives

James P. Zeumer - VP of IR and Corporate Communications

Richard J. Dugas, Jr. - Chairman, President and CEO

Robert T. O'Shaughnessy - EVP and CFO

Analysts

Adam Rudiger - Wells Fargo Securities

Ivy Lynne Zelman - Zelman & Associates

Jack Micenko - Susquehanna Financial

Michael Jason Rehaut - JP Morgan Chase & Co.

David Goldberg - UBS Investment Bank

Nishu Sood - Deutsche Bank AG

Joel Locker - FBN Securities, Inc.

Stephen Kim - Barclays Capital

Stephen East - ISI Group Inc.

Michael Roxland - Bank of America Merrill Lynch

Kenneth Zener - KeyBanc Capital Markets Inc.

Robert Wetenhall - RBC Capital Markets

Daniel Oppenheim - Credit Suisse

Eli Hackel - Goldman Sachs Group Inc.

Operator

Good morning. My name is Tiffany and I will be your conference operator today. At this time, I would like to welcome everyone to the PulteGroup, Inc. First Quarter 2014 Financial Results Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions). Thank you.

James Zeumer, you may begin your conference.

James P. Zeumer

Great. Thank you, operator, and good morning. I want to welcome everyone to PulteGroup's earnings call to discuss our first quarter financial results for the three months ended March 31, 2014.

Joining me on today's call are Richard Dugas, Chairman, President and CEO; Bob O'Shaughnessy, Executive Vice President and CFO; 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.

Today's presentation may include forward-looking statements about PulteGroup's future performance. Actual results could differ materially from those suggested by our comments made today. The most significant risk factors that could affect future results are summarized as part of today's earnings release and within the accompanying presentation slides. These risk factors and other key information are detailed in our SEC filings, including our annual and quarterly reports.

With that said, now let me turn the call over to Richard Dugas. Richard?

Richard J. Dugas, Jr.

Thanks, Jim, and good morning, everyone. I'm excited to speak with you this morning about PulteGroup's first quarter operating and financial results which show the company's continued gains against our key business metrics. Equally important, I am pleased to report that the positive January traffic and demand dynamics we discussed on our last earnings call continue to develop over the quarter helping to improve our absorptions per community and giving us confidence in the ongoing recovery of housing demand.

Specific to the company, our first quarter pretax earnings of $130 million and related financial results show ongoing success consistent with our value creation strategy and focus on driving better returns on invested capital over the housing cycle. As Bob will detail shortly, gains related to this work can be seen clearly in our income statement and balance sheet. There are a couple of points I would note to highlight our progress.

First, on comparable revenues, we were able to expand year-over-year gross margins by 580 basis points to 23.8%. Gross margins are also up 60 basis points from the fourth quarter of 2013 making this the ninth quarter in a row of sequential gains. Last time our margins were at this level was back in 2005, a time when industry volumes and relating demand were obviously much higher than what we were experiencing currently. Stated plainly, we are running a much more efficient business today as we're able to generate much higher earnings at current production levels.

Second, our results show the continued benefits we are realizing from our strategic pricing strategy, which has given us a lot more opportunity to capture higher revenues and profitability for home. The average sales price for closings in the quarter was $317,000, an increase of 10% over last year. Yes, we were able to realize higher prices on our base house but as Bob will detail shortly, we saw even bigger percentage increases on option pricing and lot premiums. Again, this is reflective of our pricing strategies which focus on offering a great base house and then allowing the consumer to select those options and upgrades they value most and for which they are willing to pay.

In addition to the extensive new product development and testing work we are implementing for all new floor plans, we put a lot of analysis into the options we offer and our lot pricing strategy as we work to capture the maximum value from each home we sell. And finally, I would highlight that our sign-ups for the quarter which totaled 4,863 homes. The sign-up number is down 6% from last year but it was generated from 10% fewer communities, indicating improved absorption paces within our communities, a positive sign given the strength in last year's first quarter demand.

Given how demand developed and the favorable comments we have heard from our divisions during the quarter, I am really pleased with our sign-ups for the period. The combination of solid pricing, improved absorption pace and cancellation rates that dropped back below 12% for the quarter leaves me optimistic about the remainder of the spring selling season. We believe the industry is still in the early stages of what will be a sustained multiyear recovery but one that will develop at a more measured pace than passed housing recoveries given demand and supply constraints.

Certainly, we could see the pace of recovery accelerate but I think we would have to see an increase in the rate of employment growth and better mortgage availability especially for entry level buyers. To that point, we get a lot of questions about the entry level buyer and PulteGroup's strategy for addressing this segment which is most directly served to our Centex brand. At less than 30% of current overall housing demand compared with historical rates above 40%, this group is underrepresented in the overall housing recovery thus far.

However, we are seeing acceptable levels of entry level activity in certain markets and our most recent survey show millennials remain very positive about housing and homeownership. When demand from this buyer demographic returns, we will be ready. We continue to refine our product designs and seek new land investments that are well located to serve this buyer. We have the knowledge and financial capacity to react quickly as demand evolves and are excited about the future opportunities for the segment.

Now let me turn the call over to Bob for more details on the quarter. Bob?

Robert T. O'Shaughnessy

Thank you, Richard, and good morning. PulteGroup indeed has gotten off to a great start in 2014 with continued improvement across a number of important operating and financial metrics. These gains allow us to post a strong Q1 financial performance. First quarter home sale revenues totaled $1.1 billion which is comparable with last year. As Richard mentioned, we realized a 10% increase in average selling price to $317,000 which was offset by the 10% decrease in closing volumes to 3,436 homes.

We were able to achieve this despite the difficult weather conditions in much of the country as our operating teams worked hard to minimize this impact on our production schedules. The higher average selling price in the quarter was driven by price increases at all three of our brands including 13% increases at the Pulte and Del Webb to $387,000 and $322,000, respectively, and a 5% increase at Centex to $203,000.

We did see a shift in the mix of closings during the quarter which break down as follows; 41% from Pulte, 32% from Del Webb and 27% from Centex. This compares to our prior year closing mix of 46% Pulte, 28% Del Webb and 26% Centex. With our land investment continuing to skew to our Pulte brand, we expect that our mix of closings will continue to be weighted toward move-up and active adult product.

For the quarter, our gross margin was 23.8% which represents an increase of 580 basis points over Q1 of last year and 60 basis points over Q4 of last year. Margins in the quarter benefited from mix of homes delivered in the period as well as our strategic pricing programs which allow buyers to select the lots and options that they value most. The success of this strategy can again be seen as lot premiums in the quarter increased 41% to $12,000 per home while option dollars gained 12% to $44,000 per home.

Margins in the quarter also benefited from further reductions in sales discounts which fell for 1.6%. This is down 180 basis points from last year. In dollar terms, sales discounts in the quarter were approximately $5,200 per home compared with just over $10,000 last year. While we're likely getting to the lower end range of what's possible for discounts, we'll keep working hard to squeeze out every dollar we can.

In addition to pricing benefits, we continue to focus on driving greater construction efficiency and lower build cost to our common plan and related known strategy. For the quarter, commonly managed plans accounted for 30% of closings, up from 21% in Q4 of last year keeping us on track towards our goal of 40% by the end of 2014. With rising material and labor costs, increasing the use of commonly managed floor plans is critical to our ongoing efforts to enhance margins.

Our current estimates show house cost up roughly $1,400 or about 1.2% for home from 2013. As we've commented on prior calls, rising land, labor and material costs are an increasing margin headwind. We see opportunities to enhance margins from here through common plan management, strategic pricing and other initiatives. But quarter-to-quarter volatility does exist depending of the mix of homes delivered and seasonal demand.

Turning to our overheads. SG&A spend in the first quarter totaled $145 million compared with $130 million last year. Our spend in the period is consistent with comments we made in Q4 and reflects investments we're making in support of common plan management, product and purchasing zones and our information systems.

Our Financial Services business reported pretax income of $22 million in the quarter which is up from $14 million in Q1 of last year. These results include the reversal of $19 million of mortgage repurchase reserves offset by a decrease in operating profitability due to the more competitive operating conditions that currently exist within the mortgage industry.

We're obviously pleased to reverse a portion of our reserves related to mortgage origination exposure. This accounting reflects the improving housing market, recent settlement activity relating to known repurchase requests and the settlement of significant exposures relating to originations through the end of 2008 with a significant investor. We will continue to work diligently to minimize and resolve our repurchase-related exposures.

Looking at our taxes, we reported $55 million of expense which represents an effective rate of 42%. Our first quarter rate was higher than our previous guidance of 39% due in large part to adjustments to our deferred taxes relating to changes in certain state tax rates. In the prior year, we reported less than $1 million of tax expenses, maintained a full valuation allowance against our deferred tax assets.

In total, PulteGroup reported pretax income of $130 million for the quarter which is up 58% over the prior year. Net income for the period was $75 million or $0.19 per share compared with $82 million or $0.21 per share in 2013. We've gotten off to a strong start in 2014 and are well positioned to build on this performance as we move through the remainder of the year.

Looking beyond the income statement, we had 5,121 homes under construction at the end of the quarter of which 19% were spec. The spec percentage is comparable with Q1 of last year but down sequentially from Q4. During the quarter, we put 9,700 lots under control and invested a total of $325 million in land acquisitions and developments. As has been the trend for several quarters, most of these land positions are raw and require development, but we were able to increase the percentage of deals under our options would allows us to control but not own the positions until needed.

At the end of Q1, we had 120,000 lots under control of which 26% are under option. Roughly 23% of our lots are finished with another 19% currently under development. As previously reported, we authorized $2 billion for land acquisition and development in 2014 and we continue to target this level. We are committed, however, to remaining disciplined in our investment process and will invest only when acceptable risk-adjusted returns can be realized.

Looking at our cash flows, we generated $91 million of cash flow from operations despite the increase in our land investment activities. During the quarter, we spent $45 million to repurchase 2.2 million shares of our stock at an average cost of $19.95 per share. As of March 31, we had $190 million of capacity remaining under our existing share repurchase authorization.

We also completed our previously announced transactions to repurchase $246 million of senior notes. We recorded a charge of $9 million resulting from these redemptions. At quarter end, our total debt outstanding is down to $1.8 billion of which $1 billion matures in 2032 and beyond. And our debt to capital has decreased to 28%.

After completing all these transactions, we ended the quarter with $1.3 billion of cash. The improvements we realized over the past couple of years in our operating and in turn financial metrics have been dramatic and are being recognized as PulteGroup has been upgraded recently by each of the major rating agencies.

Let me finish with just a few more data points before turning the call back to Richard. We generated net new orders for the first quarter of 4,863 homes which is a decrease of 6% from last year. As Richard mentioned, year-over-year community count was down 10%, so we did experience higher absorption paces in the period. Benefiting from the strong price appreciation we've driven, the dollar value of sign-ups actually increased 2% to $1.6 billion.

In the quarter, net sign-ups decreased 8% for Pulte, 6% for Centex and 4% for Del Webb. However, absorption paces were up 7% in Del Webb and 29% in Centex offset in part by an 8% decrease in Pulte communities. The year-over-year increase seen in our Del Webb brand is a positive given the deep land positions we maintained in those communities.

We ended the quarter with a community count of 584 which is down 10% from the end of last year and consistent with our guidance that we expect to operate from an approximate range of 560 to 580 communities during all four quarters of 2014. We opened more than 40 communities in the quarter and remain on track to open approximately 190 new communities over the full year.

We ended Q1 with a backlog of 7,199 homes valued at $2.4 billion which compares with our prior year backlog of 7,825 homes at a comparable $2.4 billion value. In conclusion, our Q1 results represent a strong start to the year and are further confirmation that our efforts towards running a more efficient and profitable business are meeting with success.

Now let me turn the call back to Richard for some final comments.

Richard J. Dugas, Jr.

Thanks, Bob. As I said at the outset, we experienced good demand in the quarter with generally stable to rising prices and gains and absorption paces suggestive of buyers coming back into the market especially in March. We'll have to see how demand develops over the remainder of the spring selling season, but we are certainly encouraged by what we saw.

Taking this view down a level, looking at the East Coast, sales activity was stronger in the south and softer as you move into the northern markets. Demand trends were strong in Florida and generally positive up to the Carolinas, but as you move through D.C. and into the New England area, demand was respectable but certainly not as strong as the other areas in the east.

We saw a similar pattern in the central third of the country with demand in Texas arguably among the strongest in the country. Again, as you continue heading north, you can still see pockets of strength but conditions were a little more mixed. The one outlier is Michigan which continued to see good traffic and demand even in the face of the snowiest winter in more than a 100 years. Inventory is just so tight in Michigan that any available supply is quickly snapped up and often in higher prices.

The west obviously didn't have to deal with snow and cold, but I think the market is still finding its level after the significant price increases experienced over the prior 24 months. On a relative basis, the Pacific Northwest and Northern California saw better demand during the quarter while Arizona felt more pressure. As for April, we are seeing stable to slightly lower traffic levels of highly qualified buyers compared to March which is a normal seasonal trend and keeps us optimistic for demand over the remainder of the spring selling season.

As always, I want to thank the employees of PulteGroup as they are the people who really make this business successful. For a number of our markets, it was a tough quarter to be a homebuilder, so I want to recognize all those divisions that worked so hard to keep sales and production on track under some tough weather conditions. Thank goodness spring has finally sprung.

Finally, before opening the call to questions, I want to make you aware of a press release we will be issuing later today. I'm excited to share with you an announcement we made to our employees this week that we have named Ryan Marshall to become Executive Vice President of Homebuilding Operations and Harmon Smith has been named Executive Vice President of Field Operations. Both will be reporting directly to me.

Ryan has been with the company for 13 years and Harmon 25 years. In addition to being strong operators, both have been instrumental in advancing our value creation strategy which has helped raise our financial and operating results to be among the best in the industry. And moving them into these new roles, we are aligning additional resources in direct support of value creation and allowing them to focus full time on advancing key underlying initiatives to ensure we realize the maximum benefits.

Some of you may have already met with them during market tours in Florida or Texas. For those who haven't, I'm sure there will be opportunities to speak with them in the future. The press release we issue later today will provide more details on these changes and their respective backgrounds of Ryan and Harmon. Thanks for your time this morning.

I'll now turn the call back to Jim Zeumer. Jim?

James P. Zeumer

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

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from the line of Adam Rudiger with Wells Fargo Securities. Your line is open.

Adam Rudiger - Wells Fargo Securities

Good morning. Thanks for taking my questions. Bob, I realized you just gave us the absorptions by segments but I, truth be told I had a little trouble writing that quickly. Can you elaborate a little bit more on just the trends you're seeing and the patterns by buyer segment?

Robert T. O'Shaughnessy

In terms of absorptions…

Adam Rudiger - Wells Fargo Securities

Yes, I mean just wanted some more color on the whole idea at the entry level, buyers challenged and move-up, active adult might be better positioned and I just wanted either some more commentary to either prove or disapprove or just discuss that whole idea?

Robert T. O'Shaughnessy

Yes. So what we saw was that we – I'll give you the data again. On sign-up, we saw 8% decline at Pulte; 6% at Centex, 4% down at Del Webb, but our absorption paces; Pulte was down 8%, Centex was actually up 29% and Del Webb was up 7%, so absorption paces are up 4% overall. And I think that there's a couple of things happening there. Certainly the Texas market was very strong in the first quarter which is where we have a really – a larger percentage of Centex operations and so that 29% pace increase is reflective of the really strong market we saw in Texas. The Pulte market was influenced in part by Arizona where we saw a slowdown from what we saw as really, really strong results last year. And again, the highlight to us is that across the board the Del Webb product absorptions were increasing during the quarter, which is pretty consistent with what we've seen over the last couple of years that we've said that we think it's been a little bit slower back to market for them, but we saw nice demand out of them in the first quarter.

Adam Rudiger - Wells Fargo Securities

Okay. And then the second question just on gross margin, I think previously you talked about all else equal, the debt reduction could have added maybe a point to the gross margin expansion. With the most recent debt refinancing and some of the increase in commonly managed plan contribution, can you comment on what the updated thoughts were there?

Richard J. Dugas, Jr.

Adam, this is Richard. The recent debt refinancing won't impact margins until '15 and '16 and beyond given the way that we amortize interest overall. So we still like our margin trajectory. As we said, there is going to be quarter-to-quarter volatility from here, but we've been real pleased with what we've been able to do.

Robert T. O'Shaughnessy

Just to clarify, year-over-year, the margin benefit from the reduced interest cost coming through cost of sales is 110 basis points. So that 580 basis points increase in total margin, 110 basis points is interest related.

Operator

Your next question comes from the line of Ivy Zelman with Zelman & Associates. Your line is open.

Ivy Lynne Zelman - Zelman & Associates

Thank you, operator. Good morning, guys. Congratulations on a great quarter.

Richard J. Dugas, Jr.

Thanks, Ivy.

Ivy Lynne Zelman - Zelman & Associates

One of the things you guys talked about is the common floor plan and all the success of the initiatives. Can you give us just the numbers with respect to the closing that benefited from the common floor plans and what do you anticipate over the multiple, say, next two years or so? I know you've given goals before, if you can confirm that they are on track or where you are, maybe ahead of expectations? I also think there is a lot of skepticism despite your great performance around the fact that your margin performance, gross margins specifically, is really just a result of purchase accounting from the Centex acquisition and that you've got all this old Centex mothballed stuff and it's all going to hit the P&L at some point and your runway going forward is not there as where we're optimistically viewing it. So maybe just a clarification, Bob, go through sort of the Centex legacy assets and much of which is gone from what I understand, but I think it would be really helpful especially for the bearers that are listening?

Richard J. Dugas, Jr.

Ivy, this is Richard. A couple of thoughts. First of all, with regard to common plan management, we were at 30% of our deliveries in the end of Q1 from common plan management. That's up from 21% in Q4 and substantially below that earlier last year. We are well on track toward our goal of 40% by the end of this year and our long-term goal is 70%. So to answer that question, I would suggest that if anything we're at or slightly ahead of the pace that we projected to get to, so we feel very, very good about it and it's beneficial to the company. I'll answer the first part of the gross margin question and then throw it to Bob for more detail. Our gross margin efforts have been very, very focused on a combination of common plan management and strategic pricing actions that frankly along with mix are driving all of our margin benefit. In fact, margins on legacy land that has been around a while are in fact not benefiting from purchase accounting. They are actually a little bit of a drag on our margins overall relative to the land that we've underwritten the last four or five years. So, I would suggest for any of the bearers listening we're earning every single dollar of the gross margin improvement that we're getting. I'll just highlight again a couple of things Bob mentioned. Our discounts are extremely low and we are continuing to work those hard. Our option revenue is very high, a lot of premiums are very high and we're working on base house improvement through our common plan management work. So, purchase accounting doesn't have much to do with it. Maybe Bob can illuminate that a little more.

Robert T. O'Shaughnessy

Yes, just for color more than half of our closings in the recent quarter are from newer vintage lands, so stuff that wouldn't have been impaired. And we actually like that land better. To Richard's point, the margins are a little bit, not dramatically so, but a little bit better and I would suggest that the land we're underwriting today, we will feel better about too.

Richard J. Dugas, Jr.

Let's remember that the purchase accounting didn't allow us to write land down to incredibly low levels. It was market levels at the time. So we did the right accounting but that's not what's causing our margin expansion.

Ivy Lynne Zelman - Zelman & Associates

Well, that's very helpful. Elaborate, if you would or ask you to elaborate on what is mothball today relative just to total company and that's not assets that you can get a return on. I know that you really changed course in your return focus and you paired down on assets that weren't going to give you that return. So for clarifications, how much of the land that you hold on balance sheet is mothball today and not going to generate the returns that would justify keeping them?

Robert T. O'Shaughnessy

In terms of percentage, we've got some longer life assets in the Del Webb portfolio but we've been pretty actively selling things that we don't think would generate a return over time. There was another $5 million in this quarter, several hundred million dollars over the last two or three years. So it is a small percentage of our book of what you would describe as mothballed and non-returning assets.

Operator

Your next question comes from the line of Jacky Micenko with SIG. Your line is open.

Jack Micenko - Susquehanna Financial

Hi. I got a new nickname

Richard J. Dugas, Jr.

It's going to stick with you, Jack.

Jack Micenko - Susquehanna Financial

I hope not. Looking at the G&A, Richard, it picked up a little bit in the quarter. Anything behind that and I guess as an extension of that, is the Atlanta headquarter expense, is that all in the numbers? Is there anything to think about? I think that move is going to take place later this year, anything on the expense side to talk about the ratio moving up a little?

Richard J. Dugas, Jr.

Jack, frankly, G&A came in actually slightly better than our own internal projections and very consistent with the guidance Bob gave in Q4. So, we're making some investments in some IT systems that have been needed. Our common plan management zone infrastructure to help sustain these excellent margins we're posting, we're spending some money there. And there is less than a couple of million bucks in this quarter relative to the headquarters' relocation, so that wasn't a big driver. So again, while the dollar number is clearly higher than the last year, it's well within the guidance range, actually a little bit lower than Bob projected at Q4.

Jack Micenko - Susquehanna Financial

Okay, great. I notice the (indiscernible) slide is finally been removed. I agree that issue is largely behind the industry. Can you remind us what the reserve is left after the release and was there anything – was there any specific communication with the FHFA or was it just more assumption and behavioral patterns that led to the release?

Robert T. O'Shaughnessy

So at the end of the quarter we'll have $102 million reserve that's after reversing the 19 million. And actually we were able to negotiate a settlement with one significant investor which prompted us to look at this during the quarter and coupled with rising home prices, which certainly reduces the exposure on individual loans. The GSEs have indicated that they are largely through their book. We've seen a decline in the current year in the number of requests – a significant decline in the number of requests that we're receiving. So on balance we looked at it and felt comfortable to release the reserve. Like we've always said, we will look at it every quarter. If there are things that happened that merit adjusting the reserve, we'll do it. We'll explain it to you when it happens.

Jack Micenko - Susquehanna Financial

Okay, great. Thank you.

Operator

Your next question comes from the line of Michael Rehaut with JP Morgan. Your line is open.

Michael Jason Rehaut - JP Morgan Chase & Co.

Thanks. Good morning and congrats on a good quarter. The first question I had was the continued solid execution around the gross margins and you've clearly had a lot of success there. I guess as you look at the common plan management implementation, I guess you're roughly halfway through getting to your long-term goal. I was hoping if you could kind of remind us how you think about how that could incrementally benefit the gross margin from here being, I guess, in a 27%, 28% pre-interest range, if you expect any incremental benefit from here or it would be more just operational and efficiency related perhaps balance sheet inventory turn, et cetera?

Richard J. Dugas, Jr.

Mike, this is Richard. Commonly managed plans definitely have better margins than non-commonly managed plans. So we would expect some benefit from commonly managed plans increasing in the future. Two other points to make; as Bob rightly points out, some of the elements of common plan management such as value engineering and (indiscernible) costing which we've been doing for a while are already embedded in our non-commonly managed plans. So, there's a portion of that benefit that we're not waiting to get. But the biggest point that I'd like to make is that our commonly managed floor plans are better floor plans for the buyers and the absorption rates per home, the take rates from buyers on options and things like that are better, significantly better than our non-commonly managed plans. So, in addition to getting a cost benefit we're getting a revenue benefit. And the combination of those keeps us extremely bullish to push this initiative as fast as we can.

Michael Jason Rehaut - JP Morgan Chase & Co.

I appreciate that. I guess it kind of leads to my second question on the absorption rate. I appreciate the additional color, Bob, that you pointed out in terms of the Centex benefit from Texas and Del Webb obviously continuing to perform nicely. As you think about absorptions on a longer term basis, where do you think that can go from here? I think a lot of the industry is – they're kind of all over the map in terms of where they are relative to history. Some are seeing absorptions back to middle of the past decade, some are still well below that, how are you thinking about that particularly as you're looking at kind of new communities that you expect to come online over the next two to three years?

Richard J. Dugas, Jr.

Mike, Richard again. Listen, it is impossible to predict absorption paces for a community. There is just so many multiple factors that impact things. I will tell you this. I really like the land that we're buying. As a company, the disciplined investment process that we have put in place three years ago now is really benefiting us and obviously we've been focused on return on invested capital more than growth, and I think you're seeing in our numbers some of the benefits of the good land we've been buying. We have really stayed away from any B or C locations. So, how does that translate to absorption paces per community? It's hard to predict. I'll tell you we're pleased with what we delivered in Q1.

Operator

Your next question comes from the line of David Goldberg with UBS. Your line is open.

David Goldberg - UBS Investment Bank

Thanks. Good morning, everybody, and a great quarter.

Richard J. Dugas, Jr.

Hi, David.

David Goldberg - UBS Investment Bank

I wanted to start and maybe follow up on Mike's question a little bit, and what I want to get an idea of is I think most builders, yourselves included, are using current pace, current price, current cost when they're doing their underwriting. But given your heightened sensitivity to risk in the model and the kind of increased caution around capital allocation and focus on return on capital, I'm wondering how you think about sensitivity analysis, upside down tied especially with the volatility and pace right now, how do you think about that? If you can give us some color and maybe some specificity when it comes to trying to underwrite deals in this market which is such a choppy selling season?

Robert T. O'Shaughnessy

David, it's a good question and there is no definitive answer to that. What I can tell you is when we see the pro formas that our deal teams put together, we've got an asset management committee here that vets very deal. So the field will go through it and they've put comps together on what pricing is and what paces are going to be and it gets challenged. And so in markets where we have seen rapid run-ups, we actually will tend to, I don't want to say discount that but at least challenge. Is it sustainable? Maybe one of the most important factors around that is what supply is coming online around it. So if you've seen a community that's selling very well and you use that as a comp, well, gosh, is there anybody selling against them, what's going to come to market by the time we get there, it goes a little bit to Mike's question too in terms of we're looking two and three years out typically. So we really do try and flavor that into the expectations of what we can deliver. Again, it's not a – we're going to apply a 10% discount because they run up. It's more around how do we feel the markets and job creation is going to be there and then what supply do we see in the market?

Richard J. Dugas, Jr.

David, if I can just add a little color. This is Richard to that. We have a saying internally, stay the course and we've been staying the course and that's probably the most important thing we could do depending on market conditions is not kid ourselves about what's happening, as Bob indicated, and stick to our discipline. And I believe that's helped us continue to do the right thing with land transactions.

David Goldberg - UBS Investment Bank

That's great color and it's actually a good segue to my second question, because Richard you mentioned about the kind of hope that the entry levels is going to come back and trying to be positioned I think and be ready for that move when it does happen and yet the land acquisition is very focused on A locations and not B, C locations. And so I'm just trying to get an idea from a market research perspective how do you think about being ahead of when the entry level does come back. Clearly you have the product in the Centex brand, but from a land perspective, how do you stay ahead of peers and make sure you don't end up chasing those positions?

Richard J. Dugas, Jr.

David, number one, we're not going to underwrite transactions that don't meet our return criteria and the truth is we haven't found that many that meet our return criteria for the entry level recently. So our goal is to get ahead of it by ensuring we're challenging ourselves on what that buyer wants, how do we deliver tremendous supportability and if credit eases, be able to implement product very quickly that meets those demands. So we do have a strategy team internally that looks at future trends in each of the segments and we're working hard to understand the needs of millennials. Millennials are stretched with student loan debt. Obviously down payments are hard to come by, so I can't give you a lot of specificity on that but I will tell you we're not going to get caught flatfooted if credit eases and not have product and offerings ready to go. The goal is to stay ahead of it. The tough part is, is that going to be a year from now, two years from now, when does that buyer return more meaningfully? We don't know but the point was we'll be ready.

Operator

Your next question comes from the line of Nishu Sood with Deutsche Bank. Your line is open.

Nishu Sood - Deutsche Bank AG

Thanks. First question I wanted to ask was about kind of following up on Dave's question there. Centex brand doing well in Texas, so is that a reflection of first-time buyer demand reemerging maybe locally just in Texas or is that kind of a reflection of the historical positioning that Centex was the Texas brand, so maybe Centex might skew a little bit more – move up in Texas?

Richard J. Dugas, Jr.

Nishu, I'd say it's a combination of those two things plus a very strong economy in Texas. Texas economy is adding jobs. Houston's the biggest housing market in the country now. I recently did a tour in March to all of our Texas markets and was amazed at the activity going on in all four of the major metro areas with just the overall economy. So I think a combination of strong economy, our legacy position there and an emergence of the entry level category there, but largely fueled because of the strong economy.

Nishu Sood - Deutsche Bank AG

Got it. And second question, the new EVP positions you highlighted and congratulations to Ryan and Harmon on those. Is that a reflection of the success you've seen with some of your operating strategies, the common floor plans and efficiency in production? So is that kind of a formalization or recognition of that or does that tell us that there are major new directions you're going to pursue and therefore these positions reflect more of that?

Richard J. Dugas, Jr.

Nishu, there are very clearly focused on adding incremental resources to what we've already been pushing, so definitely not signaling anything new. But candidly we've had a very flat structure for the past four or five years and despite all the gains that we have made, we believe there is more to go there. And Harmon and Ryan are exceptional operators that have been very involved in all of the value creation work and delivered great results in their respective geographic areas. So we're bifurcating the roles, if you will, where Harmon can help us focus on pushing each of the field operations to drive out additional benefits and Ryan's role kind of overseeing our homebuilding operations, sales and marketing functions in the company will be derived around capability development to help us further enhance some of the things that we've been working on. So very much staying the course but more horsepower behind it, if you will.

Operator

Your next question comes from the line of Joel Locker with FBN Securities. Your line is open.

Joel Locker - FBN Securities, Inc.

Hi, guys. Just on your backlog conversion rate going forward, do you expect it similar, say, just in the second quarter to the 53% you guys reported last year?

Richard J. Dugas, Jr.

Joel, this is Richard. We won't give any guidance on that but I'll tell you we don't have many specs, so we have a very healthy backlog, a very strong backlog and it's just a matter of getting those homes delivered but to add to that with incremental specs converting is not going to happen because we don't the specs. So, read into that what you will. We're very, very focused on a bill to order model and it's benefited us in many, many ways, so we're committed to that.

Joel Locker - FBN Securities, Inc.

Right. And also on your amortized interest that fell I guess around 70 basis points sequentially, I think 440 down to 370. And that kind of got down further faster than I expected and what do you expect going forward to – I mean you think that level is going to stabilize there, that 370 basis points or do you see maybe up or down going forward?

Robert T. O'Shaughnessy

Yes, we don't give commentary on margins by quarter. What we did indicate is the total expense for the year would be down about $50 million or $55 million from last year. It doesn't come in straight lined during the year, it comes in based on closing volumes. So you'll see a little bit more expense in margin quarters that have higher closing volumes. But again, call it 205-ish million we're thinking for the year in terms of total expense. And to Richard's comment earlier, the activity that we did in the first quarter of this year doesn't move the needle on current year interest. That would be out years.

Operator

Your next question comes from the line of Stephen Kim with Barclays. Your line is open.

Stephen Kim - Barclays Capital

Hi, guys. Thanks very much. I wanted to follow-up actually on the management change question. Can you talk a little bit about how you see the structure of Pulte going forward on the homebuilding side as different or distinct from the kind of management structure you had on the homebuilding side sort of pre-crisis, if you will? I know that things have obviously gone through a lot of changes. I imagine you probably learned some lessons and some things you don't want to replicate and I was curious as to what you thought those things were and how we might be able to look at what you're doing today as being consistent [Technical Difficulty]?

Richard J. Dugas, Jr.

…we think we have a long way to go to kind of push to where our vision is. And then those are kind of the primary responsibilities for Ryan. With regard to Harmon's role, again, very, very focused on having the field operations report to him and digging into all the opportunity areas that I've been able to dig into frankly over the past four years myself. But we still see lots of pockets of opportunity and my role has been fairly broad, and we need to get a little bit more incremental focus on some of the areas to take it to the next level. So all this signals is stay the course with additional very, very well respected and highly qualified individuals to lead these efforts. So relative to the long term – the past structure that the company has had, I don't think it's all that similar. We still have a very flat structure in the company and we're likely to keep it that way.

Stephen Kim - Barclays Capital

Okay, great. Well, I'm certainly looking forward to following up there with them. You made a comment about absorptions being up 29% at Centex, the Centex subdivision. I'm very curious about how much of that can be explained by Texas alone or if you were to ex-Texas out, did you still see Centex communities performing better on an absorption basis and are you looking to increase the number of Centex divisions or subdivisions that you're going to be opening up as a result of this? Just trying to understand how you process that outperformance and absorptions at Centex?

Robert T. O'Shaughnessy

Stephen, as we highlighted, it was – the largest driver of that was the Texas market where we happened to have a lot of Centex communities. I candidly haven't done it ex-Texas but I would suggest that it was up across the board but I don't know that percentage. We can probably get that for you. In terms of opening new communities, our investment in land has been – we've talked about 75%, 80% Pulte of the 9,700 lots we put under control in the first quarter, less than 10% of those were Centex lots. So I wouldn't expect a large flood of openings from us, because we just don't have the land to do that. As Richard highlighted, we think if we see whether it's in specific markets or more broadly, a move towards that buyer becoming more active, we think we can get on the lots pretty quickly.

Operator

Your next question comes from the line of Stephen East with ISI Group. Your line is open.

Stephen East - ISI Group Inc.

Thank you. Good morning, and congratulations, also, guys.

Richard J. Dugas, Jr.

Thanks, Stephen.

Stephen East - ISI Group Inc.

Richard, you all are really the only one in the industry that can move their gross margin significantly from internal things you all are doing at this point. If you look at the external market, what do you think that's giving you right now? It's gotten significantly tougher particularly out west and that type of thing. Has your strategy needed to change any? Do you need to be tighter with pricing or looking forward, I guess, I'm wondering are your incentives going to have to move up at least because of what the markets demanding and that type thing?

Richard J. Dugas, Jr.

Steve, listen, we're not immune to the market vagrancies that happen around the country. So I don't want to imply that our business is not subject to the overall broader trends. I will tell you this, we have shattered some internal assumptions around what can be done in any different component of pricing and frankly cost. And so as a couple of folks prior to you on the call here have indicated, don't underestimate the impact of what the things that we're doing internally can do and we're continuing to work hard on those. So, I would suggest we do have an ability to drive efficiency in our business that's significantly greater than we have in the past. That will be offset some by headwinds. Bob indicated some numbers on pricing and labor costs and what have you that are up. But look, I like where we are. I tell our teams internally we should feel really good about where we are because we've earned our success. We haven't just relied on the market improvement that lifts land values to lift margins like we used to, quite frankly. So, feel good about that with some offset that makes us subject to market conditions. So hope that helps.

Stephen East - ISI Group Inc.

Okay, that does. And then if you look at monthly, you gave some idea of what was going on. As you've looked at this year, has it unfolded – including into April, has it unfolded from a monthly perspective in a typical fashion? And then you had in prior quarters you had talked about still metering sales, et cetera. I'm guessing based on your performance you didn't – that's probably starting to dissipate out there if not gone away completely. And along with that on the Del Webb, are you getting – you've talked about pricing power. You've got the highest margins there. Do you see this as a driver of your margins, the primary driver of your margins moving forward?

Richard J. Dugas, Jr.

So you snuck in three or four there honestly.

Stephen East - ISI Group Inc.

I did.

Richard J. Dugas, Jr.

See I caught that. So, listen, a couple of things. With regard to metering paces we are still metering paces in some markets. A good example would be Northern California which is red hot and a few other markets. I think directionally you're right. Probably we're not metering as much as we were but frankly we could have posted more sign-ups in the quarter had we wanted to kind of let it run. But where we already have a six or seven or even eight-month backlog that didn't seem to make a lot of sense for us given the way we're running the business. So, we feel like we're operating the right way. With regard to Del Webb, we're excited about what's happening in Del Webb. As Bob indicated, the overall focus for the company given how much land we have for Del Webb has been very, very positive and I do think that's a positive for us overall. However, I would just point out as Bob indicates, our overall margins are up a similar amount for each of the brands and the reason I highlight that is that's driven outside of market vagrancies. That's driven from common plan management, from focus on discount, from focus on lot premiums. I mean the numbers Bob gave you on options and lot premiums we're very proud of. Those were things we were not paying attention to like we should have four or five years ago. So, hope that helps overall.

Operator

Your next question comes from the line of Mike Roxland with Bank of America. Your line is open.

Michael Roxland - Bank of America Merrill Lynch

Thanks very much and congratulations on a very good quarter, especially given the backdrop. Given the slowdown in Arizona, what steps are you taking to address that, if any? And excluding Arizona, how did the Pulte brand do?

Richard J. Dugas, Jr.

So a couple of comments on Arizona. Arizona is clearly not as strong as it was. But I tell our people given the total volume and margin we're driving out of that market, it's still a very good market. Frankly, I would suggest that our land positions there are very well located. Our teams have done an excellent job. And while we've certainly seen some softer conditions in Arizona, it's not a bad market or one that we're concerned about. We're actually quite happy with our overall performance there. So I'd just point that out. I'm sorry, what was the second part of your question?

Michael Roxland - Bank of America Merrill Lynch

If you exclude Arizona, how did the Pulte brand itself do?

Richard J. Dugas, Jr.

As Bob indicated, absorption paces were down. We were hit a little bit with weather conditions in the Midwest, in the Northeast where we have quite a bit of Pulte brand. But we were pleased with our overall efforts on the Pulte brand. I'm sorry, I don't have a specific number for you if we exclude Arizona.

Michael Roxland - Bank of America Merrill Lynch

No, that's fine. I appreciate all the color. And then just a last question on the community count, obviously it increased to 584 this quarter. I know Bob you mentioned that you're still looking at 560 to 580 for the duration of the year. What occurred during 1Q such that you exceeded your own expectations with respect to key community count? And should we expect really community count growth to be at the higher end of the range that you've indicated in the last couple of quarters?

Robert T. O'Shaughnessy

No. Again, we still feel comfortable 560 to 580. It's really the vagary of when does a particular community close, when does a particular community open. Again, this isn't a signal of something structurally different in our community count.

Operator

Your next question comes from the line of Ken Zener with KeyBanc. Your line is open.

Kenneth Zener - KeyBanc Capital Markets Inc.

Good morning, gentlemen.

Richard J. Dugas, Jr.

Good morning, Ken.

Kenneth Zener - KeyBanc Capital Markets Inc.

Given the success that you're demonstrating in the common plan, I wonder if you consider replacing since you took it out of your put-back side with one that kind of traps your landed vertical costs. And if you would even perhaps comment on that on a year-over-year sequential basis how the land is changing given that you are highlighting other factors like lot premiums, et cetera. But I think the core vertical versus land if you'd comment on your opinion talking about that?

Richard J. Dugas, Jr.

Listen, I appreciate the suggestion. We are trying to do our best to give as much color as we can around that with so many different factors that move the needle, but point taken. We are clearly not relying just on land appreciation to drive our margins. There is a lot of internal effort that's going on there. So, Ken, we'll take that under consideration.

Kenneth Zener - KeyBanc Capital Markets Inc.

It's a very clean way to prove your point. Second, could you comment on Arizona? I think there is obviously a lot of one-off things occurring there. But to the extent there was once a distressed MSA, can you comment why you think that might not be a precursor for what might happen as other distressed markets get more existing inventory back? Florida, obviously, with different foreclosure processes is a very different stage of the game. It's not our view but if you can kind of address why you think it would not be a precursor for inventory pressuring new home sales in other markets? Thank you.

Richard J. Dugas, Jr.

Well, I don't see a lot of excess inventory coming to the market in a lot of places. There was a fairly rapid and focused land grab, if you will, in Phoenix 24 months ago when that market started heating up and a lot of that supply is there today. When we talked to our operators around the system, we don't hear of a lot of inventory coming into the market in any specific market overall. Obviously, it's a function of demand versus supply. But I'm relatively comfortable that we're not going to see a lot of other markets with a lot of supply there. Ken, if I could just reiterate a comment I made a minute ago. Arizona is still a very good market for us. I know a lot of folks have written about the softness in Arizona, so to speak. But I'll go back to something I mentioned earlier on this call. We're buying the right kind of land in the right locations where buyers want to be. And I wouldn't suggest we're immune from the overall vagaries of that market, but we are posting exceptionally strong margins and good sales paces if not phenomenal sales paces like we were 24 months ago. So at least for our business, we're pretty happy with Arizona.

Operator

Your next question comes from the line of Bob Wetenhall with RBC Capital Markets. Your line is open.

Robert Wetenhall - RBC Capital Markets

Hi. Good morning.

Richard J. Dugas, Jr.

Hi, Bob.

Robert Wetenhall - RBC Capital Markets

I wanted to ask you guys, your average order price is up nearly 9% which is terrific and you have actually manageable comps going forward. Do you think that kind of pace is sustainable in the current demand environment going forward for average order prices?

Richard J. Dugas, Jr.

Bob, it's hard to say. You can calculate what kind of a backlog is. It's going to depend a good bit on mix. Bob's comment on Del Webb is going to be important there to the extent that Webb continues to accelerate. That's a positive for us obviously given the ASPs that we drive there. It's hard to predict. I really wouldn't want to comment on that just because who knows exactly what's going to deliver in a given quarter and what the demand environment is going to be. So I don't know, Bob, if you've got any other color of that?

Robert T. O'Shaughnessy

No, I think that's exactly right.

Robert Wetenhall - RBC Capital Markets

Okay, understood. One question on the balance sheet. I know you guys have done a great job of managing towards driving return on capital higher and debt to capitalization now is the lowest it's been in a very long time at 28%. You've got a lot of cash on the balance sheet, 1.3 billion. What's the longer view of how you see the balance sheet in two to three years and what do you want to do with the cash? Thanks very much.

Richard J. Dugas, Jr.

So let me start out and then ask Bob to comment more specifically. I think we have demonstrated that we want to be balanced with our capital. And I wouldn't expect that to change going forward. If you go back, history would say that putting all of our investment into land is not necessarily the best thing for our shareholders. I think we've learned that and you can continue to expect us to be balanced overall and frankly, I think we demonstrated in Q1 all four aspects of capital that we could – all four aspects of spend we could put our capital toward with increased land spend, obviously a dividend continuing to buyback our own stock as well as repurchase debt. So, I suspect more of the same. I know that's not a lot of specific commentary. Bob, anything else you'd like to mention there?

Robert T. O'Shaughnessy

No. I think you got it.

Operator

Your next question comes from the line of Dan Oppenheim with Credit Suisse. Your line is open.

Daniel Oppenheim - Credit Suisse

Thanks very much. Was wondering if you can talk about – you talked about the absorption based on the different brands, that's very helpful. When we think about the strength in Texas and the Centex lower price point and what that means, do you think there's going to be any impact on margins as you move forward from that?

Richard J. Dugas, Jr.

Dan, it's a good question and I'll remind everyone that our main focus is return on invested capital. Obviously, we're happy with our margin focus. But we'll handle it and be happy to underwrite a transaction with a 30% return and an 18% margin as an example. So, it depends on what happens with that category overall. It is a category, generally speaking, that has generally higher turn characteristics and lower margin characteristics. But given what Bob indicated in terms of the overall land investment that we have, I think our results for the next period that we can view are going to be largely driven by what's happening with Pulte and Del Webb. Centex, clearly, is having an impact overall, but I don't know that it will move the needle a whole lot one way or another in the short term.

Daniel Oppenheim - Credit Suisse

Got it. Okay. Thanks. And I guess the other question is just could you provide some great color in terms of the cost per home in terms of the very modest increase there (indiscernible). As you sort of look at the land that's likely to flow through, how do you look at sort of the land cost on a per home basis and what is likely to come through this year?

Robert T. O'Shaughnessy

We haven't commented on that historically and I would tell you we highlight that land costs are going up but I think that's true for everybody. What we have highlighted is that margin performance in fiscal '14 will be better than fiscal '13. You saw that in the first quarter. Our margin in Q2 was 18.8 to 20.9. Our backlog visibility would suggest margins closer than what we thought more recently. So I think you'll see improvement there. And Richard just highlighted pricing, so you can I guess backend into the lands done.

Operator

Your next question comes from the line of Eli Hackel with Goldman Sachs. Your line is open.

Eli Hackel - Goldman Sachs Group Inc.

Thank you. Just wanted to go to a comment you made at the end of your prepared remarks just on April. I think you just said – at least a little clearly for me, so I just wanted to understand what you were trying to say with April as regards to your optimism for the rest of the spring selling season?

Richard J. Dugas, Jr.

Yes, Eli, what we said was that the traffic levels are slightly down from what we saw in March and we said that's the normal seasonal trend where we typically see traffic peak in March and then trail off a little bit through the rest of the selling season. So we said – our comment was we are seeing a normal spring selling season unfold which leaves us optimistic for the balance of the year. That's what we said.

Eli Hackel - Goldman Sachs Group Inc.

Great. And then just one quick one. What was the comp rate in the quarter?

Richard J. Dugas, Jr.

Just under half.

Robert T. O'Shaughnessy

Yes, just under 12%, 11.5%.

Operator

I would now like to turn the conference back over to our presenters.

Richard J. Dugas, Jr.

Great. Thank you very much. I know there is a lot of conference calls queued up this morning, so we're going to stick to our scheduled time. We're certainly available for any follow-up questions or emails. Thank you very much for your time on today's call and we'll look forward to speaking with you next quarter.

Operator

This concludes today's conference call. You may now disconnect.

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