Roger Cregg - Chief Financial Officer and Executive Vice President
James Zeumer - Vice President of Investor & Corporate Communications
Michael Schweninger - Principal Accounting Officer, Vice President and Controller
Richard Dugas - Chairman, President, and Chief Executive Officer
Josh Levin - Citigroup Inc.
David Goldberg - UBS Investment Bank
Ivy Zelman – Zelman & Associates
Joshua Pollard – Goldman Sachs
Michael Rehaut – JP Morgan
Michael Widner - Stifel Nicolaus
Nishu Sood - Deutsche Bank AG
Daniel Oppenheim - Crédit Suisse First Boston, Inc.
Megan McGrath, Barclays Capital
Carl Reichardt -Wells Fargo
Alex Barron - Housing Research Center
Jay McCanless – Guggenheim Partners
John Benda – Susquehanna International Group
Jay Chadbourn – Merrill Lynch
Buck Horne - Raymond James & Associates
PulteGroup (PHM) Q2 2010 Earnings Call August 4, 2010 8:30 AM ET
Good day, ladies and gentlemen, and welcome to the Q2 2010 PulteGroup, Inc. Earnings Conference Call. [Operator Instructions] I would now like to turn the presentation over to your host for today’s call, Mr. James Zeumer. Please proceed.
Thank you, Operator. I want to welcome everyone to this morning's call to discuss PulteGroup's results for second quarter and six months ended June 30, 2010. On the call with me today are Richard Dugas, Chairman, President and Chief Executive Officer; Roger Cregg, Executive Vice President and Chief Financial Officer; and Mike Schweninger, Vice President and Controller.
For those of you who have access to the Internet, a slide presentation, available at www.pultegroupinc.com will accompany this discussion. The slides will be archived on the site for the next 30 days for those who want to review it later. As a reminder, on August 18, 2009, PulteGroup completed its merger with Centex Corporation. Results reported in the release and on this call reflect the inclusion of Centex's operations for the second quarter and six months of 2010, although results for the comparable prior period have not been adjusted for this merger.
Finally, I want to alert everyone that certain statements and comments made during the course of this call must be considered forward-looking statements as defined by the Securities Litigation Reform Act of 1995. PulteGroup 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 PulteGroup's annual report on Form 10-K for the year ended December 31, 2009, and this morning's press release for a detailed list of risks and uncertainties associated with the business. Certain statements during this call also contain references to non-GAAP financial measures. See this morning's press release, which is available on our corporate website, pultegroupinc.com, for reconciliation of the non-GAAP financial measures to the comparable GAAP numbers. As always, at the end of our prepared comments, we will have time for Q&A. I’ll now turn over the call over to Richard Dugas for his opening comments. Richard?
Thanks Jim, and good morning everyone. In preparing for today’s discussion, I reviewed our comments from PulteGroup’s last two quarterly conference calls. During those calls, we talked about expectations that new home sales in 2010 would likely be comparable to 2009, and how we had set up our business to be successful in that type of difficult macro-environment.
At the time, we also talked about how important the Centex merger would be in accelerating PulteGroup’s overall pace of operating and financial improvement. The significant gains in PulteGroup’s second quarter financial results demonstrate that we are achieving the goals that we have set for the company.
As Roger will detail in a moment, we continue to realize improvement throughout our operations. As homebuilding revenue roughly doubled to $1.3 billion, homebuilding margins, before land-related charges and interest costs, expanded to 17.2%. SG&A dropped to 11.7% of home sale revenue, and reported earnings per share of $0.20 a share represent a major step in the process of rebuilding shareholder value for our investors.
Successfully executing against a small number of key initiatives helped the company to deliver improved operating and financial results. The company significantly reduced a year over year pre-tax loss of $6 million, which includes $45 million in land- and mortgage-related charges and reflects lower impairments and the benefit of gross margin expansion and better overhead leverage within our homebuilding operations.
In combination with our ongoing work against these key initiatives, the dramatic improvement in PulteGroup’s performance was driven in large part by last year’s merger with Centex. By putting the two organizations together, it allowed us to meaningfully increase the number of homes we delivered and the corresponding revenue we recognized. In turn, having moved quickly to integrate the businesses and capture expected overhead synergies, we were able to realize significant leverage on our SG&A spending, which as a percentage of settlement revenues dropped by almost 600 basis points.
We have been focused on our efforts to reduce overhead costs during the prolonged market slowdown, but achieving these results would have been difficult without the merger. The merger integration is all but complete, but the benefits will continue to support our results for many years to come. As concerns about potential integration risk rapidly dissipate, comments from more and more investors acknowledge the positive business impact the transaction is having on our business.
Overall, we are pleased with our second quarter financial results and the progress we continue to make in strengthening our operations and improving our market position. PulteGroup associates throughout the country have worked hard to close homes, control costs, and execute against our key business strategies. I want to thank them for their continued efforts in support of the company.
Beyond the improvement in our second quarter numbers, we appreciate that the focus of the past couple of months was, and remains, the current state of housing following the April 30 expiration of the federal tax credit. The falloff in demand has been well documented and in truth has likely exceeded just about all expectations.
We believe that it is a positive sign that our demand has been stable since the initial pullback, but overall volumes remain well below normal seasonal demand. There is certainly no shortage of economic research attempting to estimate how much demand was pulled forward, and how long any effects will be felt. Some believe the housing malaise could linger, while others think that some level of rebound could be evident within months. And while the industry could experience a modest seasonal lift in the back half of the year, within PulteGroup we’ll continue to err on the side of caution in terms of how we manage our operations until a more sustained rebound is evident.
In the end, almost regardless of how future demand plays out, we still believe that the tax credit had to end. We need to know the true level of demand without government stimulus distorting the market so that we can continue to properly position our business for ongoing improvement.
Beyond the immediacy of any tax credit impact, for the industry to experience a meaningful and sustained rebound in demand over the long term we need a stronger economy, job creation, and better consumer confidence. At a run rate bouncing around 300,000 to 350,000 new home sales annually, our industry continues to face incredibly low demand. Supply, be it traditional home sales, vacancies, short sales, foreclosures, shadow or otherwise, is obviously important, but right now the industry’s biggest issue is a lack of buyers.
The good news is that coming off such low levels, even a modest improvement in fundamental demand can be experienced relatively quickly. Given the low interest rate environment and incredible home values, even slight improvements in local market economies, or consumer sentiment, can help convert home shoppers into home buyers.
Our operations are in a good position as we work through these next few months. With only 1,100 finished spec homes, or just slightly more than one per community, our inventory position is certainly manageable, as we are benefitting from our strategy of not chasing the tax credit buyer earlier in the year.
Right now let me turn the call over to Roger Cregg for additional details on PulteGroup’s second quarter financial results, after which I’ll provide a little more detail on market conditions during the quarter.
Thank you Richard, and good morning everyone. Revenues from home settlements for the home building operation increased approximately 93% from the prior year quarter to approximately $1.3 billion. Increased revenues reflect the increase in unit closings that were above prior year by approximately 101%, mainly attributed to the merger with Centex.
The average sales price decreased approximately 4% versus the prior year quarter, to an average of $251,000. This decrease is attributed to the mix of greater first-time homebuyer volume due to the Centex merger in addition to the geographical and product mix of homes closed during the current quarter.
In the second quarter, land sales generated approximately $7 million in total revenues, which is an increase of approximately $3 million versus the previous year’s quarter. The sales in the quarter mainly reflect the sale of lots and land parcels to other builders.
Homebuilding gross profits from home settlements for the quarter, including homebuilding interest expense, was approximately $159 million, versus a loss of $71 million in the prior year quarter. For those with access to the webcast slides, I refer you to slide number six, the adjusted margin analysis, which outlines our gross margins.
Homebuilding gross margins from home settlements as a percentage of revenues was 12.6% compared with a -10.9% in the second quarter of 2009. Adjusting the current quarter’s gross margins for land and community valuation charges, interest expense and the acquisition accounting write-up for the Centex work in process resulted in a conversion of 17.2% compared to an adjusted margin of 16.3% for the first quarter of 2010 or a sequential improvement of 90 basis points on an adjusted basis. On a comparative basis versus the previous year’s second quarter conversion of 9.4% the adjusted increase is 780 basis points. The improved margins are a direct result of lower sales incentives, house cost improvements, and stable market pricing.
Homebuilding interest expense increased during the quarter to approximately $38 million, versus approximately $33 million in the prior year. Included in the interest expense of $38 million is an additional $5 million of expense related to the 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 $20 million.
Consistent with prior quarters, we have reviewed all of our communities for impairment indicators. Based on this review in the second quarter, we identified and tested approximately 30 communities for potential impairment in valuation adjustments. The recorded valuation adjustments on approximately 16 communities for the quarter, of which approximately 9 communities, or 56%, had been previously impaired. Additionally, we impaired three projects which represented approximately $15 million, or 75% of the total $20 million in impairments.
Also for the quarter, the acquisition accounting work-in-process charge is approximately $500,000. The total net gain from land sales posted for the quarter was approximately $4 million. The gain is mainly attributed to the sale of lots and parcels of land in the quarter.
Homebuilding SG&A expenses as a percent of home sales for the quarter was approximately 11.7% or $147 million, an increase of approximately $33 million or 29% versus the prior year quarter. This increase reflects the additional incremental overhead associated with the merger of the Centex operations. In addition, the second quarter includes approximately $1 million for employee severance and related costs. If we look at the SG&A line on a pro forma basis, our expenses reflect a reduction of approximately $44 million, or 23% from the combined Pulte and Centex SG&A expenses from the previous year’s quarter.
In the homebuilding other income and expense category for the quarter, the expense of approximately $9 million includes the write-off of deposits and pre-acquisition costs resulting from the decision not to pursue certain land acquisitions in the amount of $2.3 million. Also included in the category for the quarter is an expense of approximately $1.3 million associated with overhead expense reductions for lease exit and related costs and an additional $1.4 good will impairment charge related to the completion of a final valuation of self-insurance liabilities assumed in the Centex merger.
The homebuilding pre-tax income for the quarter of approximately $11.8 million resulted in a pre-tax margin of approximately 1% on total homebuilding revenues. The pre-tax income is inclusive of charges related to the valuation adjustments in land inventory and investments, land held for sale, good will impairment, severance and related charges, and the Centex work in process adjustment for a total of approximately $32 million.
The pre-tax loss from Pulte’s financial services operations for the second quarter was approximately $9 million, relatively flat versus the previous quarter. The loss in the quarter is mainly attributed to an increase in loan repurchase loss reserves by approximately $17 million during the quarter in severance and lease exit costs related to the merger of approximately $1 million, all partially offset by an increase in loan origination principal volume from an increase in settlements.
Total mortgage principal origination dollars was $667 million, an increase of 65% when compared to the same period last year. The increase is related to greater home settlements from the homebuilding closing activity for the quarter, with the addition of the Centex volume. Total agency originations were $622 million. Non-agency originations were approximately $10 million, and broker or non-funded loans were approximately $35 million. Additionally, within the funded agency originations, FHA loans were approximately 43% of the loans funded from the financing line in the quarter, compared to approximately 40% in the first quarter of 2010.
Pulte Mortgage’s capture rate for the current quarter was approximately 76% and the average FICO score for the quarter was 741. In the other non-operating category, pre-tax loss for the second quarter of approximately $9 million includes corporate expenses of approximately $10 million, partially offset by net interest income of $1 million resulting from invested cash balances.
If we look at this line on a pro forma basis our expenses reflect a reduction of approximately $43 million or 81% from the combined Pulte and Centex expenses from the previous year’s quarter. For the second quarter the company’s pre-tax loss was approximately $6 million. The pre-tax loss for the quarter is inclusive of $50 million in charges related to the valuation adjustments in land inventory and investments, land held for sale, severance and lease action and related costs, acquisition accounting write-up for the Centex work in process inventory, loan repurchase loss reserves, and the goodwill impairment.
The net income for the second quarter was approximately $76 million, or $0.20 per share as compared to a net loss of approximately $189 million, or a loss of $0.74 per share for the same period last year. The quarter reflects a net benefit from income taxes of approximately $82 million, primarily due to the favorable resolution of certain federal and state income taxes. The number of shares used in the EPS calculation was approximately 380.4 million diluted shares for the second quarter of 2010. The total shares outstanding at June 30 were approximately 382.7 million.
Reviewing the balance sheet for the current quarter, we ended with a cash balance of approximately $2.7 billion, increasing approximately $163 million from the first quarter of 2010. We received approximately $103 million in cash refunds during the second quarter, related to our federal NOL carrybacks. House and land inventory ended the quarter at approximately $4.9 billion. The decrease in house and land inventory and land held for sale for the current quarter was approximately $146 million from the first quarter of 2010. During the second quarter, our new investments in land were in rolling lot option takedowns and purchases of approximately $62 million and land development spending of approximately $166 million, offset by a modest reduction in house inventory by approximately $53 million.
With approximately $2.7 billion in unrestricted cash at the end of the quarter, we had no outstanding balance drawn on our revolving credit facility. The company’s gross debt to total capitalization ratio was approximately 56.6% and on a net basis 31.9%. Interest incurred amounted to approximately $68 million in the quarter, compared to $53 million for the same period last year.
PulteGroup shareholder equity for the second quarter was approximately $3.3 billion. We repurchased no shares during the quarter and the company has approximately $102 million remaining on the current authorization.
I will now turn the call back to Richard for some additional comments on the quarter. Richard?
Thanks Roger. As we’ve done in the past, before opening the call to questions we wanted to provide some additional details on market conditions during the quarter. Although given how well the industry demand has been tracked, it seems almost real time during these past few months. I’m not sure there’ll be much new information.
Signups for the quarter totaled 4,218 homes, which is an increase of 25% over the same period in 2009, and essentially flat with the first quarter of this year. On a pro forma basis, just assuming Pulte and Centex were one company last year, second quarter signups are down 32% on 9% fewer communities. I’m sure it won’t be a surprise to hear that April was the strongest month of the second quarter with year over year signups slowing meaningfully as we moved through May and into June.
Given the impact of the merger on year over year comparisons and the tax credit impact mid-quarter, I will focus more on signup trends within the second quarter of the year. In terms of units sold month to month during the second quarter, our Gulf Coast, Southeast, and Northeast operations held up the best. In fact, net signups in the Gulf Coast and Southeast areas improved May to June, led by gains in Texas, North and Central Florida, and the Carolinas and Tennessee.
Our Midwest, Southwest, and West areas experienced more significant slowing during the quarter, with Arizona and Nevada facing the most difficult demand environment. This is consistent with demand conditions we have seen for much of the downturn, with Phoenix and Las Vegas being among the most challenged of the markets.
From a product standpoint, I would highlight that signups within our Del Webb brand were consistent year over year for the second quarter, as well as for the first six months of the year. Active adult represents roughly one third of PulteGroup’s business and is an area that has been under pressure since the fourth quarter of 2008. Demand stability, and obviously growth, sometime in the future within this buyer segment is important for us. Del Webb communities are much larger than traditional single family communities and can drive tremendous same-store sales volume when demand is healthy. Assuming this buyer segment has found its footing, the timing could be advantageous as we will be moving into the stronger fall and winter selling season for many of the Del Webb destination communities which are located in warm-weather markets.
In sum, demand pulled back after April 30, which was to be expected, although the pullback was greater than expected. Demand has been relatively stable after the initial change, but it’s going to take a few months before we have a truer read on demand. One point I’d like to make is to caution people who keep slicing demand data segments smaller and smaller. You hear people attempting to gauge business conditions based on shorter and shorter timeframes. While useful, there can be a lot of noise in this data.
Moving beyond signups, we ended the quarter with 150,000 lots under control, of which 90% were owned and 10% were under option. Of these lots, approximately 48,000 were fully developed, with an additional 21,000 currently in the development pipeline. During the second quarter, we remain active in the landmark at having approved 31 new investments. Total lots involved were just over 2,200, so you can see that the basic project profile remains the same in that we’re focusing in on smaller finished lot deals that can be controlled via an option agreement and that can pencil to a mid-20% return or better.
As we’ve talked about before, good deals are getting harder and harder to find. Land development has been close to non-existent over the past several years, so few new developed lots are coming into the market. From a location standpoint, most of the “A” location properties have been picked over and pricing has been moving higher, so it’s getting tougher to make deals pencil to an acceptable return. We have certainly been opportunistic in pursuing these deals, but we have always known that you couldn’t build a sustainable business strategy on the backs of these small transactions.
With the recent demand softness, you may see the deal flow ease a little, which isn’t an issue given our strong land position. We’ll have to see if the pause is long enough for land prices to pull back a little. Given our balance sheet, we can remain actively involved in the process, but given our supply of finished lots we can certainly be selective in what we buy.
In conclusion, we made great progress in the quarter and the first half of 2010 and enter the second half of the year as a much stronger, more efficient company. We’ll be optimistic that demand conditions improve while remaining cautious in how we operate the business. As we’ve said in the past, we’re well positioned to take advantage of the market opportunities that develop.
Let me now turn the call back to Jim.
Thank you Richard. We will now open the call to questions. As we’ve done on prior calls we ask you to keep it to one question and one follow up. If you have an additional question at that point, please feel free to get back into the queue, or you can follow up with us directly after the call. Operator, give any needed directions and we’ll now open the call up to questions.
[Operator instructions.] And your first question comes from the line of Josh Levin from Citi. Please proceed.
Josh Levin - Citi
So I guess if you back out the tax item, it was close to a break even quarter, that obviously includes the charges, but this is probably the high point for volumes for the year. So in terms of trying to be profitable going forward, what’s the game plan? I mean, do you sort of wait to see if demand picks up or do you start looking for additional ways to cut SG&A here? How do we think about your profitability strategy going forward?
Hey Josh, it’s Richard. I don’t think we wait. Clearly it’s going to be a challenging year and we’re looking for all opportunities to improve profitability. At this point we still feel that we can be profitable for the year, but given the pullback in demand it’s going to be a steeper hill than we thought. So our view is to look at not only SG&A but additional ways to drive revenue and from a charges standpoint, we have not seen significant reductions in pricing across the markets nor do we anticipate that going forward. Some of the charges we had in the quarter were on a couple of isolated projects that Roger can detail a little bit more. So we obviously can’t forecast those going forward. It’s difficult. You have to come through the period. I don’t know, Roger, if you want to speak to that a bit.
On the impairments we had basically probably three projects that I mentioned in the prepared remarks. One of them was a repositioning from a Del Webb project to a Pulte project and then the other couple were basically changes in estimates on the projects themselves, so again, not material across the country. They were very much isolated and I’m not anything systemic in price erosion to drive more impairments.
Okay, and one follow-up if I may. You’ve shown sequential gross margin improvement the past few quarters. How do gross margins trend from here? Should we think they’re still going to be up, or flat, or down? Especially given the demand environment.
Yeah Josh, Roger again. I think what we’re going to see is somewhat of a plateau from here. A little bit, could be some opportunity up, but we’re seeing some of the head winds now start to come from the material costs that we saw go up earlier in the year. So we’re seeing a little pressure on that, but again we continue to work on house cost improvements throughout the country. So I would tell you we’re probably expecting it to plateau from this point a little bit and it could move a little bit one way or the other but nothing meaningful.
Next question comes from the line of David Goldberg from UBS. Please proceed.
David Goldberg - UBS Investment Bank
Wanted to follow up on Josh’s question a little bit, on the pricing and the strategy and I guess what I’m trying to get an idea about is it seems to me like we’re hearing more and more already about some of your competitors cutting prices to try to drive a little bit of volume at this point given the weakness we’ve seen. And I’m trying to understand how that relates to the impairment, the indication of impairment, testing you guys do, and how you kind of think about what prices you use in the model, how you think about how pricing’s going to fare moving forward, and sales basis is going to fare moving forward. When you think about potential impairment as you look forward.
Yeah David, Roger. I think when we take a look at each one of those, as the markets go through they’re looking at the competition, and what they have to do to sell homes. And typically what we’ve done in the past if we need to compete and prices continue to fall significantly we were competing in dropping our pricing. And so that was creating the weight from the impairment side as margins were diminishing.
Again, you look at the volume as well, and so volume’s an indicator of price as well, so if you’re not selling anything, maybe because you’re out of bed on the pricing in general, and so those are the indicators that the markets continue to look at and adjust to. So I would tell you, again, competitively across the country it’s not systemic across all the markets and all the communities. I know you continue to hear that from builders, but they’re isolated. There might be isolated situations where they are in a particular market, or segments of markets, where they are adjusting price to move some volume.
And again, we end up looking at how deep that volume happens to be in the market relative to where we are in position, and whether we have to react to that or not. So each one of those is very specific, but very detailed to the market in looking at what your local competition is doing and how deep that supply is.
Got it. And then, just as a quick follow up question. You guys were kind enough last quarter to provide kind of a sales pace per segment and Richard I appreciate the detail on segment performance but I’m wondering if we could get something like that, kind of a sales pace by segment this quarter and kind of how each segment compared to each other.
Yeah, this is Mike. Just take a look at Centex, about 41% of our signups came from Centex, 31% came from Pulte, and 28% came from Del Webb.
And how does that compare to the community count layout?
Community count, if you take a look at Centex, 377; Pulte, 307; and Del Webb, 155.
All right. Thank you very much.
Your next question comes from the line of Ivy Zelman from Zelman & Associates. Please proceed.
Ivy Zelman – Zelman & Associates
The impairment concerns in the market are pretty pervasive and analysts are very concerned about another big substantial increase, so Roger, maybe if you could just elaborate a little bit more on the details of what you have that is arguable on a watch list? Horton disclosed a watch list yesterday; I don’t know if you guys have ever done that. But how much of your land is undeveloped that may have been mothballed and therefore really has potential with more capital investment in the grounds, sewers, roads, and pipes that need to be put in place but you could arguably be at risk of not getting your money back when you think about the cash that you invested initially? Just kind of give us some comfort that pricing. How much does pricing have to go down before you would be worried, Roger? And recognizing as you said it’s market by market, it’s project by project, but I think we need, as analysts, more comfort from you guys to know that something draconian has to happen in order for you to see a big increase as opposed to quarterly, if it’s $10, $20, $30 million here and there, we understand that’s going to happen, but a huge wave coming? That’s a long question but the same topic.
Ivy, it’s Richard. I’ll start with that and then turn it over to Roger for some details. First of all, I just want to assure everybody that our strategy is not to lower price from here on a widespread basis to try to drive volume. Frankly, I’ve been very close to the operations recently, and I’m not hearing anybody say that we are in need of wholesale price adjustments. Frankly, largely because the market operators don’t feel that it’s going to drive that much incremental volume. Maybe a little bit here and there. So actions we’re likely to take on price are very specific and isolated to communities and frankly well over half of our impairments this quarter were driven from things unrelated to price. In one case, a strategy changed on a large project, and in a couple of other cases the estimate changes in the individual project. So I just want to reassure folks that we do not see, at this point big impairments returning. That’s not to say that isolated projects can’t be there, so with that kind of backdrop overall, maybe Roger can give some color about the watch list so to speak, and that.
Yeah Ivy, our watch list is pretty small. When we look at where we’ve been over the last almost 40 years, the adjustments we’ve taken, many of them constantly quarter after quarter after quarter we set the level of pricing based on the formulas that the accounting dictates. So you can’t be ultra-aggressive to write everything down to zero, and naturally you wouldn’t want to. I think you can see by the level of the margins that are coming through we’ve been spreading that gap. And the gap’s been spreading because we’ve been more disciplined on the pricing. Now if we were to become undisciplined that creates a whole other level of environmental change on impairments in general, but that’s not been our strategy. So we think we have a fair amount of cushion in there for further decreases if that were the case. And then again, you just need to look at, again, the overhead levels that you support, as Richard said you could go back to the overheads and adjust those if pricing continues or would continue to deteriorate significantly. So I think from a major projects, the largest projects we feel comfortable where we are, with where the values are, where we’ve taken them down on the book, and then again, just environment community by community is going to dictate the level that goes on, I think each quarter there going forward. But we don’t feel exposed as significantly as we had in the past, just given the more stable pricing environment.
Just a follow up Roger. Can you quantify what percent is raw ground and then secondly, Richard, you mentioned that you’re not going to lower price and start a price war. Unfortunately some of our, of your competitors are lowering prices as a strategy. Horton said yesterday they’re going to sell and close on whatever price they need to. That affects the appraisals. So recognizing if you’re across the street from them, or even a neighboring community a few blocks down, it could have an impact on appraisals. So how do you mitigate that being an issue, even though you’re not necessarily going to try to compete against them, that’s a big problem in the market with appraisals?
Okay, I’ll start with the answer, Ivy, and then go back to Roger. In terms of trying to compete against any individual builder, Horton or others, we are clearly subject to what they do on a community by community basis. But I would tell you that is isolated to the communities where we directly compete with them. You’re right around appraisals, but the way I’m thinking about it, Ivy, is if you go back to 2007 and 2008, the market was on a wholesale, free-fall decline, and no one could find any footing, no matter what was happening, so price kept spiraling down, and obviously hundreds of millions of dollars of impairments per quarter resulted from that. I’m not seeing that kind of environment, despite what Horton is doing or a couple of other builders. You know, our opinion collectively internally is that price is not going to move the business a lot, and therefore I suspect on the edges you’re going to see some competition there, and we’ll have to deal with appraisals and other issues like that, but I’m not expecting things to drop 10% from here. And again, as I’ve been talking to our operators it does not appear that that’s moving a lot of product. Things are – it’s not a price problem. It’s a consumer confidence issue. So we’ll have to compete community by community but I think that’s going to be more spotty, so it’s not keeping me up at night.
Yeah Ivy, Roger. Just on the undeveloped, basically, I’ll give you on a lot basis, I don’t have the dollars in front of us, but on the lot basis out of the 150,000 lots that we talked about, there’s roughly about 100,000 that are undeveloped, so that’s almost 2/3. Again we could follow up with you on the specific dollars.
Your next question comes from the line of Joshua Pollard from Goldman Sachs. Please proceed.
Joshua Pollard – Goldman Sachs
Hi, I’ve got yet another question on impairments and then I’ll turn it to some of the cost saving side. You talked about a potential pull back in land prices that would create and investment opportunity. What would that do to some of the land holdings that you currently have? Would you potentially have to write those down as a result?
Yeah, Joshua. This is Roger. No, we would not. You always buy land at different prices, so if you buy one that is lower than another one, it doesn’t mean you go back and adjust your book. The only time you adjust your book is if you felt that that was impaired. And again, the land pricing itself doesn’t do that. It’s the house pricing, the margins, the pace, and those types of things that will typically drive the impairment. So you could very well, which we’re doing today, buying land for less than we have on our books in some instances, which has given ourselves opportunities to improve margins. I think you’ve heard that from the other builders as well. Some of them are focusing more of their attention on doing acquisitions than actually using the land that they own today to be able to capitalize on that type of margin improvement. So overall that’s a good thing if you can buy it for less, but it does not mean you impair any of the book.
Great. The second piece of the question - you guys had outlined $350 million of annualized cost savings. Because we didn’t have the original basis for that number, could you quantify what you’ve saved to date, and then you made some comments in your prepared statement about potentially capitalizing on more opportunities that were a little bit more long term. Could you outline what some of those are and quantify them for us please?
Sure, again Joshua. This is Roger. Basically, as I mentioned in the first quarter, we had about over $115 million in savings in SG&A alone. This quarter we mentioned again about $86 million if you followed the script. So that’s about $200 million in the two quarters. I didn’t go back and try to calculate the fourth quarter for you, but again, there was some savings there as we put the companies together in the fourth quarter. Interest alone was probably at a half a year probably about $65 million, so this year we’re probably running $265 million. I would tell you we’re probably in the $300+ million range in two more quarters to go until we’re at the end of the year. So, we outlined about $440 million. We’re well on track to that number.
We talked about another $150 million to $200 million in the purchasing side. We’re starting to see some of that come along in the margins. You do see some of the improvements in the margin as being helped by some of the cost, house cost savings that we’re able to get by putting vendors together. More of that should come as we move in the future. Now what I always said was that number in the purchasing side was always soft, because you don’t always get to demonstrate it if you have commodity costs beginning to rise. So when we think we had an opportunity to save money in that $150 million to $200 million, if commodity costs go up, which they have earlier this year on a year to date basis pretty significantly, that also plays in the headwind of actually dropping it to the gross margin line. So well on track for the $440 million and then again the other $150 million to $200 million we’re seeing that starting to come through the gross margin side and will hopefully in the next couple quarters as well.
Your next question comes from the line of Michael Rehaut from JP Morgan. Please proceed.
Michael Rehaut – JP Morgan
First question, on the goodwill balance, I think we’ve talked a little bit about, obviously on the land impairment side, but I believe a couple of quarters ago when you took the large charge you had referred to a $9.01 stock price threshold. So I think there were some people expecting some type of additional charge there, as you fell below. I was wondering if you could just discuss the dynamics there and how we should think about that going forward? And then I have a second question.
Yeah Mike, I think what what we said, it wasn’t really a threshold. Really what it was was an indicator of value, and so there’s a very sophisticated, complicated formula you work through when you’re looking at the book value relative to market value and future value for the book. And so all those things are taken into consideration but the specific market cap is not a single driver. It’s an indicator, and again what you look at as you book we added back deferred tax assets because, again, the market gives us value for that relative to what the book has. So, in and of itself, the market cap did not drive impairment this quarter. And again, we took a look at any other indicators that might have been there and again, none rose to the level that would indicate a full-blown impairment would be taken.
So just to follow up on that, and I’ll kind of get my second question in just in case I’m cut off. But you know, just to close out the goodwill, so going forward, what type of scenarios might there be, and it sounds like obviously it’s a complicated amalgam of different drivers, but is it safe to say that at current conditions and current market cap that - obviously you haven’t taken the charge yet – but what would the drivers be, or what would we need to see to take another material goodwill charge? That’s just following up on that question.
Second question, on the gross margins you saw some nice sequential improvement. Actually, some of your peers saw some sequential declines. How much of that was driven by some of the improvement in house costs, which might be merger-related, versus incentives? And going forward I believe you said that you expect gross margins to be in a similar range, or neighborhood. Does that mean 16% to 18%? Is there a little bit of downward bias risk given how incentives have maybe increased modestly? If you can give us some thoughts around that as well.
Okay, Mike. On the goodwill? No, I would say that there’s risk, even if the value of the stock were to go up, because it’s also based on how the goodwill is allocated across markets. So you could have markets that deteriorate that could cause goodwill on a particular asset in those markets. And so it is not as easy as just saying I look at one indicator and I can feel comfortable or uncomfortable about it. It is, again, a complicated formula. You have to look at your allocation of goodwill across the markets, and then how those actually perform. It is a future view, so you’re looking at what the future value of that generation is of the assets as well. And so, again, that’s why it’s pretty complicated, but no, you can’t just say that there’s no risk because the market cap goes up or stays the same. And those are things that we continue to look at market by market, as we would do that goodwill impairment test.
Mike on the gross margin question – Richard – we’d indicated we expect margins from here to be relatively flat with no particular bias one way or another. We’ve gotten significant benefit from the merger. Clearly the combination of the volume from both companies giving us the opportunity to open contracts with vendors has helped us. We’re going to have that, but going forward we also have the market to deal with as well. So Roger indicated that margins had likely plateaued for the time being with relatively flat outlook from here.
Your next question comes from the line of Mike Widner of Stifel Nicolaus. Please proceed.
Michael Widner - Stifel Nicolaus
I just wanted to ask you a more technical and probably easier question. A lot of my others have been asked already. On average sales price – I’m just looking at the change in, well, some of the comments you have here – it looked like there was a nice increase in average sales price in the quarter, but down in the notes you indicate that it has a composite of changes in the backlog, etc. So just wondering if you could give us an actual average sales price for the new orders in the quarter. And you know, if there’s something peculiar in there if you could comment on that.
Yeah, let’s see. We’re looking for that, Mike. Basically we did talk about the price from last year actually going down about 4% from a Pulte to the combined companies. So again, that’s mix – more mix driving in there than anything else currently, from quarter to quarter even. And we’re down even from the first quarter to the second quarter, so as we look at some of that stuff it’s more mix driven at this point by the number and the units by the markets. And again, first time home buyer relative to you know, active adult as that mix moves, the pricing moves along with it. So same thing with more closings in the western part of the U.S. versus the southern part of the U.S., where you’ll see some of those movements.
Mike, do you have some of the detail?
In terms of our – that’s with the net signup units – the 4,218 – we had about an average of $272,000 on the sales price on those. And in our backlog, we have approximately $280,000 average sales price in backlog.
Can I just add that even though we had that in our backlog doesn’t mean all those homes that we have in our backlog are all going to close in the next quarter, so you cannot extrapolate the number that’s in our backlog to get the next quarter’s average selling price. We have specs that we sell in the quarter, cancellations where a house might resell, so all of those types of things will affect overall the average selling price from quarter to quarter.
So appreciate that detail. I guess the thing I was specifically alluding to here is the $272,000 indicated average selling price. If you just do the math that you just mentioned, that’s a big increase on a Q over Q basis or year over year basis. I’m just wondering if that’s actually real, or what you indicate in the note underneath that chart is that that 1.15 [unintelligible] dollars actually includes both new order signups and some adjustments for changes in the backlog. And I’m just wondering if that changes in the backlog is distorting the number, if you did indeed see a $20,000 Q over Q increase in average new order price.
Yeah Mike, as I mentioned earlier, and as we talked in the script, the average selling price is a function of where it’s selling throughout the country. So as we did talk about the stability in price, we’re not seeing huge increases to drive that type of thing even on average, let alone specifically community by community. So it is more driven on mix than it is anything else moving through that.
Yeah, Mike as an example, we indicated our Del Webb business has been relatively flat. It’s got a higher ASP than the Centex brand, which is our entry level brand. So don’t interpret that as we raise prices on average $20,000. Interpret it as though we have a very bifurcated mix in our company with the active adult, the move up under the Pulte brand, and then Centex being the intro level brand. We’ve seen some stabilization in Del Webb, which has taken ASPs for this particular quarter signups a little bit higher. Again I’d caution you against reading too much into that relative to what closes in the next quarter due to the vagaries of cancellations, etc. But that’s what’s causing it as opposed to a real change in strategy or change in pricing philosophy.
No, understood. So that all makes sense. I just wanted to make sure there wasn’t an accounting thing in there making - like I said the note indicates that there’s changes in backlog also reflected. Just wanted to make sure there wasn’t an anomaly in there. And then just one other technical one if you could. The DTA impairment at the end of the quarter.
Yeah, basically we’re right where we were the previous quarter, about $2.3 billion in deferred tax assets with a $2.3 billion valuation reserve up against it.
Your next question comes from the line of Nishu Sood of Deutsche Bank. Please proceed.
Nishu Sood - Deutsche Bank
First question I wanted to ask was about your cash balance. You folks still have the largest cash balance in the industry. If you kind of think about the two main ways investors think about that cash balance, first as an opportunity fund to pursue incremental new land purchase opportunities, and second from the kind of security or safety or liquidity perspective, just as a buffer against weak market conditions. On the first front you folks have been very very consistent in saying we have a great land position and that’s our primary focus going forward, and on the second front, with the second quarter, obviously nice achievement of first positive EPS number according to our numbers, your first positive operating margin. Impairments have come down, gross margins have stabilized, so there’s less need on that front as well. So given that conditions may be weak for some time further here, depending on how the economy recovers, is it the right time to be considering scaling back the balance sheet to reflect a kind of shrunken housing market?
Hi Nishu, it’s Richard. I think your comments are well placed, and clearly as we’ve discuss things in the previous couple of months, and going forward, that’s our discussion around here, is what’s the best allocation. We’re a conservative company and frankly I wouldn’t expect us to change our stripes there and get real aggressive one way or another, but overall point well taken. We do think any significant liquidity concerns of a couple of years ago or a year and a half ago are gone, and that’s a good thing. So we’re looking at the best use of funding. Our preference would be to put it in inventory if we could. But frankly, and what I mean by that is land inventory, however we’re being very cautious and selective on what we’re buying. We indicated that we’re seeing some price pressure in the market on the land side and we don’t want to chase things. A 150,000 lots under our control. We made a bet, with regard to Centex, in terms of land acquisition and we’re very pleased with that. So we don’t find ourselves in a position of having to grow community count or grow store count, like maybe some peers feel like they’re in that spot. We don’t feel that way. But we are looking at all uses of cash and beyond that, Roger?
I think as we’ve stated, quarter after quarter here, that we’re waiting to see how the market moves and quite frankly the market’s moving in the opposite direction than many thought two quarters ago. We wanted to be conservative to see it. We wanted the fog to lift so to speak, so that we get a clear direction on paying down debt, investing more heavily in land as Richard mentioned, all of those things on the table that you do with the cash and the capital to make the balance sheet even stronger. So it’s not lost on us. It’s clearly about value creation and how we actually get there from our investment strategy going forward. Those are the things we’ve been waiting to see as the fog lifts and we get to see truly what the market’s going to do.
Great, thanks. That’s helpful. And second question, Roger. I wanted to ask for some more color on the income tax refund or reversal – I’m not quite sure whether that was a reversal of some of your DTA. Maybe that related to some of the Centex tax issues, the discussions they were having last year. I thought that had been resolved, so maybe if you could just give us some more color on that.
Yeah, basically there were two items and they were tax liabilities, income tax liabilities. So that’s why if you looked at the balance sheet down in the income tax area you’ll see the liabilities actually move. And so they were basically two issues that we had that were resolved during the current quarter, where we basically removed those liabilities. So the deferred tax assets really didn’t move in the quarter or the last couple of quarters. It’s been pretty much the same. Again, as I mentioned, deferred tax asset has a full valuation reserve against it. So it was – the majority of it was basically tax liabilities.
Your next question comes from the line of Dan Oppenheim from Credit Suisse. Please proceed
Daniel Oppenheim - Crédit Suisse First Boston, Inc.
I was wondering if you can talk about SG&A. You commented on the benefits of the merger bringing that down. How do you think about SG&A over the next several quarters here? What level of SG&A as a percentage of revenue can be sustained?
Dan, we’re looking at it more on a dollar basis. Revenue is obviously a function of demand and overall conversion. But we would look for our true level of SG&A to be pretty consistent going forward with what we’ve seen. And Roger, I don’t know if you want to offer any color.
Basically, I would tell you we’re in that range you saw last quarter: just over $150 million, this quarter $147 million. It could be up or down. This quarter we had some insurance adjustments in there that go through based on an actuarial review when we look at it. So some of those things influence us a little bit here and there but I think we’re sort of at that run rate at this point. If you looked at those dollars I could tell you between $140 million and $150 million on a given quarter. And again there’s nuances of accounting that run through there. You’ve got different types of accounting expenses that might move one quarter versus another quarter. But I would tell you we’re generally in that range today, pretty much on a dollar basis. And then as Richard mentioned, the leverage will come with the volume in the closings as helped us out in the second quarter here and we’ll see when the quarters go forward what the closing potential is in the next couple of quarters and the leverage on that side of it.
Just secondly, I was wondering about the comments. You’re pretty consistent saying you wouldn’t – didn’t want to chase orders at the tax credit and don’t want to cut pricing which doesn’t drive so much incremental demand right now. While that might be the right strategy, how pragmatic are you in that and if you see others doing much more and so yes it’s community by community but when it becomes a much higher proportion of your communities where you’re seeing this at what point do you look at that and say we don’t want our volume to fall off too dramatically, we need to respond to this?
Yeah, Dan that’s a good question, and frankly we do want to be competitive in the market and we will be competitive in the market. I would tell you, though, remember the banks control all the small builders in the industry and if you add up all the big builders combined you’re still not more than 25% or 30% of the total new housing market. So there’s an awful lot of folks out there who don’t have the ability to cut price frankly, because they can’t build any inventory at all because all they’re able to build is sold inventory based on the overall shutdown of lending in the industry.
So I personally think to say a builder or two builders or three builders who are chasing price are going to influence a new home building market is a little bit of a stretch. It is not the environment we were in in ’07 and ’08 where there was a constant downward spiral. Everyone was stealing everyone else’s backlog. Things kept spiraling down. We’re not seeing that. So yes we’re going to have to be pragmatic, but does that mean it’s going to affect 5% of our communities? 10% of our communities? I don’t see it being a majority of our communities, because each individual asset is asset independent.
I’ll just point out an obvious fact. I hope it’s not lost on everyone. 30% of our assets are in Del Webb. They don’t have any significant competition. I’m not sure why I’d lower price in any Del Webb community. So that wipes out roughly a third of our competitive impact right there. So just to point that out. We’re going to be pragmatic and focused as we need to be but it’s not across the board.
Your next question comes from the line of Megan McGrath from Barclays Capital. Please proceed.
Megan McGrath, Barclays Capital
Just wanted to follow up on a couple of your comments around the back half of the year. First, Richard, you said in your opening commentary I believe that there could possibly be a seasonal uplift in the back half of the year. So just wanted to follow up on that. Typically that’s not really how we see seasonality, at least from the order front in the back half of the year. So are you saying that our seasonality is a little bit off this year, because of the pullback, and we could see an upturn, or does it have to do with something you’re seeing in the market right now?
Megan it really doesn’t have anything to do with the market as we see it now. Here’s what’s going on. Typically the summer is weak. The spring is obviously the best, and we get a little bit better demand environment in September October. I think that’s exacerbated this year and effectively it wouldn’t surprise me if we see the overall new housing numbers improve modestly later this year because of the two or three month pull forward and the two or three month post tax credit lull that clearly is in the market today. I’ll point out that even if we get that I’m not talking about any exciting level of demand, right? But it’s not impossible that new home sales could go from 300,000 to 350,000 or 360,000 later this year or some number approaching that, which on a headline basis would look like a big percentage improvement. So that’s what I’m speaking about. In order to get sustainable real change, 450,000, 500,000, 600,000 new home sales it’s going to take job growth, and we get that. But that’s what I’m talking about.
Okay, thanks. That’s helpful. And then to follow up on your comments around profitability. It’s encouraging to hear that you’re still aiming for it for the year, but throughout the call you’ve talked about gross margins flattening out, SG&A kind of flat from a dollar perspective. I wouldn’t expect that your closing volume would be able to get much higher than it is this quarter, so I just want to make sure from a modeling perspective we’re all apples to apples here and not assuming anything too aggressive. Was that comment sort of post-tax write up EPS number? Was it pre-tax income? Can you help us out there?
Yeah Megan, this is Roger. It is pre-tax. It is even with the charges that are in there that we’re looking at from a pre-tax standpoint. Again it’s going to be dependent on volume in the next couple of quarters, but right now we have a forecast for that and that goes with what we had commented on.
Megan I would also point out we did say that the hill would be steeper than we saw a quarter ago. And that’s definitely the case, so what I’m basically trying to say is the number that we’re looking at is not phenomenal. I would also say secondly that we do have by far the biggest dollar value of backlog in the industry based on the way that our operating model has shifted. And that is meaningful. We intend to convert that backlog and for what it’s worth that shouldn’t be ignored. If we had half the backlog we have it would be much tougher for us to feel good about that because we’d be dependent on demand in the near term. Obviously the operating model shift in a pre-sale focus is one of the benefits. You get a little bit better consistency than if you’re hand to mouth.
Your next question comes from the line of Carl Reichardt from Wells Fargo Securities. Please proceed.
Carl Reichardt -Wells Fargo Securities
One clarification and one question. The breakout 41-31-28 Centex Pulte [unintelligible], that’s unit orders for the quarter? Is that correct?
And then I’m interested in your traffic conversion rates by those segments as well. Have they changed meaningfully, or are there significant differences among them Richard?
Well, not a lot of significant change overall Carl. Basically, as you know our [unintelligible] rate has flattened significantly from last year and the prior years. But relative to the segments, Del Webb has by far the lowest conversion. Centex and Pulte have higher conversion rates, but that’s nothing new. The active adult buyer tends to shop for six months or more before they make their purchasing decisions. So we see more traffic but a lower conversion. But not a meaningful shift in any one of them. If that’s your question – is that what you’re asking?
Yeah, that’s what I was asking. Thanks very much.
Your next question comes from the line of Alex Barron from Housing Research Center. Please proceed.
Alex Barron - Housing Research Center
I guess my first question – kind of two part – I wanted to know what the capitalized interest was at the end of the quarter and along with that, what you’re – what the policy is for how you expense or don’t expense interest. And then the second part was just your general strategy. I think you commented on your land that you don’t feel the need to chase land deals or new communities based on prices. So does that mean we will see the community count generally trend down, and you just feel comfortable staying in the communities you’ve got?
Alex, this is Richard. I’ll answer the community count first and then Roger and Mike can talk about capitalized interest. Overall we’ve indicated consistently that our community count would likely drop this year. We obviously have a large number of communities. Mike, what’s our current count?
839 communities. That’s a significant amount of leverage for us to drive, and so we are looking for community count to continue to decline in the short term. At some point that will level off based on the new investments that we’re making overall, but we are not in the mode where we feel like we have to increase community count to get leverage to avoid becoming too small in an individual market to have meaningful share if you will. So the way you should think about that is we’re being opportunistic, we’re being smart we think with land, we’re being conservative, because the market is still somewhat cloudy. But yeah, community count will continue to decline somewhat.
In addition to that we had mentioned in the last couple of calls we thought to be roughly 10% to 15% decrease in community counts. It looks more like we’ll be down roughly about 10% from the end of last year to potentially the end of this year. That would not include any new communities that we would come across for the back half of 2010. So could be some upside to that. Specifically to the question on the capitalized interest, we look at capitalized interest relative to the land we have on our books and the value of being able to carry that against the long term debt. So that’s really been the driver, and we had a slight expense this quarter, roughly about $600,000. It wasn’t material and our view there is that again we’re in good shape not to see large expense coming through on the interest side to the P&L because we can’t capitalize it. Mike, do you have the capitalized interest for the quarter?
Yeah, capitalized interest on the balance sheet at the end of the quarter was approximately $311 million and we capitalized approximately $67 million of interest during the quarter.
Your next question comes from the line of Jay McCanless from Guggenheim Partners. Please proceed.
Jay McCanless – Guggenheim Partners
I wanted to find out if the backlogs at the end of 2Q had the same segmentation as the orders that you all gave?
Yeah, I can do that. Backlog – Centex is 42%, Pulte is 27%, and Del Webb is 31%. That’s units.
That’s units? Okay. And then the second question I had, I believe you all gave the finished spec count at the beginning of the call. Could you repeat that? And then also what the total spec was at the end of the quarter?
Total specs at the end of the quarter was 3,175, of which 1,138 were finished.
Your next question comes from the line of John Benda from Susquehanna. Please proceed.
John Benda – Susquehanna International Group
Just a quick question, just to dig a little bit deeper into goodwill and possible future impairments. Just trying to relate it to the fully allowanced DTA. And wouldn’t it stand to reason that since the DTA still is fully allowanced that another round of goodwill impairments is more likely than not? For those on related instances?
No, I would say not. Again, relative to the DTA you relatively look at the market value, the book value. The book value didn’t have anything on it. Since we actually did that we took some of the deferred tax asset back in the fourth quarter of last year, which was, again, not contemplated from the standpoint of looking at what that value is. So we still think there’s more value in the DTA to go forward. So I think the correlation between DTA and goodwill is not necessarily a way to look at potential risk for further impairments. Again, as I mentioned, it’s much more complicated than that. You have to go market by market, asset by asset, the valuations for those looking at basically the life of that market that we’re in for the assets we have in perpetuity. So again there’s a lot of assumptions that go behind that that would drive that that could create risk one way or the other for further impairments or no impairments. So again I would caution that’s not something you can correlate that easily.
Your next question comes from the line of Jonathan Ellis from Merrill Lynch. Please proceed.
Jay Chadbourn – Merrill Lynch
Good morning this is Jay Chadbourn for Jonathan Ellis. My first question was how should we think about the backlog conversion ratio for the second half of the year?
Yeah this is Roger. I would just tell you that it’s not something you can look at at any point in time to say what it’s going to be. Again, it depends on how many specs you might have. You sell throughout the quarter. But I would tell you, you look at the last couple of quarters the trend has been relatively in the same range. We’ve sold or closed roughly 76%, 78% of the backlog at the beginning of the quarter to look at it. So again I’m not sure that you can clearly say that that’s what’s always going to happen. It depends on just the number of specs. But we’ve been in that range. So it is an indicator, but it’s not absolute about what we’re going to do in the next quarter.
And that number relative to anyone else is very dependent on an individual operating strategy, right? A spec-heavy strategy is going to yield something different. That’s a little more hand to mouth. Kind of a made-to-order strategy a little bit different from that. So just want to point that out.
And my second question, what percent of your sales will come from newly purchased land in 2010 and 2011?
Basically, (this is Roger again) again as we talked about not being that robust in the market overall and it’s going to be very very small. So if you’re looking at this year we’ve got, quite frankly, the transaction we’ve done this year. So the land that we actually approved this year, not in 2009 but in 2010, we expect to have roughly 170 closings from land that we acquired this year. Next year, basically, for the land we already acquired this year, roughly about 1,200. And again if all of those come to pass based on putting the house up, and the timing, and the build out, all of those very small numbers in general to our population. Again, we’re not driving the way other builders are, where they’re going to close 30% to 50% of what they acquired. Again, that’s not our strategy, so you shouldn’t expect that from us.
Your next question comes from Buck Horne from Raymond James. Please proceed.
Buck Horne - Raymond James & Associates
Just wanted to get some more clarification on the interest expense question. I just want to understand maybe a little bit better, I mean because there’s been a growing gap between the amount of interest that’s been amortized through cost of sales versus what you’re actually incurring. And I’m just wondering how long you think this gap will continue and will it normalize soon, or start to even out with each other? And just how long you think that capitalized interest balance will continue to grow?
Yeah Buck, this is Roger again. Why it’s growing is because we acquired Centex last year and basically you take that off. And so as you move forward relative to Pulte’s position, it was growing. And so that’s an accurate statement for Pulte but the reason it’s growing is because we added on the debt from Centex in the merger last year. So you’re going to get a normal increase in that relative to where we were. As we look at it certainly as you continue to, if one were to continue to deplete the land inventory, then the relative long term debt against that puts pressure on taking that through the P&L as a greater expense. So again, if we continue to deplete the inventory over the next two to four quarters, we could see some pressure on bringing that back to the P&L as an interest expense without capitalizing it.
Ladies and gentlemen, this concludes the question and answer session. I will now hand the call back to Mr. Jim Zeumer for closing remarks. Please proceed.
Thank you operator. Appreciate everybody’s time on the call this morning. If you have any questions certainly feel free to follow up with us the rest of the day. Thank you.