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PulteGroup (NYSE:PHM)

Q3 2011 Earnings Call

October 27, 2011 8:30 am ET

Executives

James P. Zeumer - Vice President of Investor Relations

Richard J. Dugas - Chairman, Chief Executive Officer, President and Member of Finance Committee

Robert Shaughnessy - Chief Financial Officer and Executive Vice President

Analysts

Robert C. Wetenhall - RBC Capital Markets, LLC, Research Division

Joel Locker - FBN Securities, Inc., Research Division

Rob Hansen - Deutsche Bank AG, Research Division

Michael Rehaut - JP Morgan Chase & Co, Research Division

David Goldberg - UBS Investment Bank, Research Division

Stephen F. East - Ticonderoga Securities LLC, Research Division

Adam Rudiger - Wells Fargo Securities, LLC, Research Division

Susan Berliner - JP Morgan Chase & Co, Research Division

Michael R. Widner - Stifel, Nicolaus & Co., Inc., Research Division

Stephen Kim - Barclays Capital, Research Division

Alex Barron - Agency Trading Group

Kenneth R. Zener - KeyBanc Capital Markets Inc., Research Division

James McCanless - Guggenheim Securities, LLC, Research Division

Steve Stelmach - FBR Capital Markets & Co., Research Division

Ivy Lynne Zelman - Zelman & Associates, Research Division

Josh Levin - Citigroup Inc, Research Division

Operator

Good day, ladies and gentlemen, and welcome to the Third Quarter 2011 PulteGroup Earnings Conference Call. My name is Tanya, and I will be your conference moderator for today. [Operator Instructions] As a reminder, this conference being recorded for replay purposes. I would now like to hand the presentation over to your host for today, Mr. James Zeumer, Vice President of Investor Relations and Corporate Communications. Please proceed.

James P. Zeumer

Thank you, and good morning, everyone. I want to thank everyone for participating in today's call to discuss PulteGroup's third quarter financial results. On the call with me are Richard Dugas, Chairman, President and CEO; Robert Shaughnessy, Executive Vice President and CFO; and Mike Schweninger, Vice President and Controller.

Before we begin, copies of this morning's press release and the presentation slides that accompany today's call have been posted on our corporate website at pultegroupinc.com. Further, an audio replay of today's call will also be available on the site later today.

Please note that any non-GAAP financial measures discussed on this call, including references to gross margins and SG&A expenses reflecting certain adjustments, are reconciled to the U.S. GAAP equivalent as part of the press release and as an appendix to the call's presentation slide deck.

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

Now let me turn the call over to Richard Dugas. Richard?

Richard J. Dugas

Thanks, Jim, and good morning, everyone. I am very pleased to report that PulteGroup's homebuilding operations, excluding any impact from the goodwill impairment and tax benefit recorded in the period, returned to profitability for the third quarter. The improvement in our operating performance reflects a combination of higher closings and significant gains in homebuilding gross margins and reduction to SG&A cost. The gains in margin and overhead are particularly important as they benefited from success in initiatives we have discussed previously.

More specifically, adjusted gross margins increased by almost 2 full percentage points from last year and 130 basis points over Q2 from our work to lower construction costs, increase presales and rebalance our base house versus option pricing model along with a better mix of closings. Based on ongoing initiatives to drive greater operating efficiencies, we are confident we can continue growing our margins over the long term.

Our third quarter results also shows significant overhead leverage as homebuilding SG&A dropped to 10.6% of sales, which compares with 14.1% as adjusted in the third quarter last year.

Over the past year, we have taken action to reduce annual overhead spending by approximately $150 million, the benefits of which are evident in our Q3 numbers. Investors typically focus on homebuilding overheads, but I would point out that on a year-over-year basis, we also significantly reduced our corporate expenses.

For the quarter, we maintained our sign-up pace compared with last year, but it was realized on 4% fewer communities. With quality land acquisitions being harder to find in today's market, we know we have to squeeze out better performance from our existing asset base and be very focused on how we allocate capital going forward. This will also help to improve our SG&A leverage and cash position over time.

I appreciate that the accounting charge related to goodwill impairment means we showed a loss for the quarter, but that does not discount the important progress we have made in our operations. Given our expectation for business conditions to be relatively stable through the end of 2011, we remain well positioned to deliver operating profitability in the fourth quarter as well.

Looking beyond our 2011 results, we are also completing our planning and budgeting work for 2012. We don't provide guidance, but I will highlight one important change that is influencing the process, namely, how we look at capital allocation in general and how we evaluate investing in the business specifically. For us to deliver meaningful improvement in our returns, we are reassessing some of our practices, including how we allocate available capital across different investment opportunities, how we evaluate and use our existing asset base to deliver its greatest value, how we prioritize the individual markets and projects in which we invest and how we can more effectively risk adjust project investments given the potential for significant differences in estimated build-out times.

As we have talked about before, the goal is to develop a more capital-efficient operating model with a greater emphasis on margins, asset turns, cash generation and higher overall returns. As with our work on margins and overheads, we will certainly be talking more about capital allocation and investments going forward as all are critical to -- excuse me. As all are critical components to improving PulteGroup's long-term shareholder returns.

Now let me turn the call over to Bob Shaughnessy to provide more details on PulteGroup's third quarter results. Bob?

Robert Shaughnessy

Thank you, Richard. I certainly share your view that the company continued to make meaningful progress in the quarter in a number of important areas, most notably, our improved financial performance.

Home sale revenues for the quarter were $1.1 billion, an increase of 7% compared with last year. The increase was driven by a 9% increase in unit closing to 4,198 homes, partially offset by a 1% decrease in average selling price to $252,000.

For the quarter, our reported homebuilding gross profit margin was 13.9%. As highlighted on Slide 5 of our webcast slides, our adjusted gross margin was 18.5%, which represents a sequential improvement of 130 basis points over Q2 of this year and a gain of 180 basis points over last year's third quarter.

Adjusted gross margin for Q3 this year excludes $49 million of capitalized interest expense, approximately $500,000 of land-related charges and $600,000 of merger costs related to CTX WIP.

In addition to the house cost, and as Richard discussed, our margin improvement over the second quarter reflects a favorable mix of presale versus spec homes closed during quarter as well as an increase in the percentage of move-up buyer sales in the period.

Homebuilding SG&A for the quarter was $117 million or 10.6% of home sales revenue. On a dollar basis, SG&A spending was down $15 million from Q2 and down $28 million from last year if you exclude the insurance reserve adjustment we reported last year.

Within other income and expenses, the company recorded a charge of approximately $241 million for the impairment of goodwill. As noted in our press release, we were required to assess the carrying value of our goodwill due to the decrease in our stock price and associated market capitalization during the third quarter. The assessment, which takes into account the decrease in the market capitalization, resulted in a determination that all of the company's goodwill needed to be written off. It's important to note that our expectations about the prospects of our business, including the opportunities we seek to improve our operating performance, remain unchanged by this technical accounting exercise.

Also included in other income and expenses is a charge of approximately $16 million for the write-down of a note receivable related to a land position in the Northeast. This charge was essentially offset in our income statement by $16 million in land sale gains realized during the period.

For the quarter, our mortgage and title operations generated a profit of $9 million, which compares with the profit of $3 million in the third quarter last year. Through the third quarter, our capture rate was 78%, which is consistent with last year, and during the quarter, we originated $550 million of loans, which is up 8% from last year and consistent with the increase in closings we saw in our homebuilding operations.

As noted in our release, we also recorded a tax benefit of $73 million, which resulted primarily from the favorable resolution of certain federal and state income tax-related matters. We expect to receive a $50 million cash refund related to this before the end of this year.

In summary, PulteGroup reported a net loss of $129 million for the quarter. To help with the geography of the items that impacted our Q3 results, I'll summarize where these items are included in the income statement. Again, the $241 million goodwill impairment charge and the $16 million note receivable write-down were recorded in other income and expenses.

We recorded $4 million of land-related charges, including $2.3 million that was included in other income and expenses and $1.5 million that was included in home cost -- home sale cost of revenues. We recorded approximately $16 million of income from land sales, and the $73 million tax benefit is obviously recorded on the tax line.

While there are a lot of moving pieces, it's clear that the business continued to make steady improvement in its operating and financial results. Echoing Richard's earlier comments, we are certainly encouraged by this quarter's numbers and pleased with having returned to profitability excluding the goodwill and tax items.

Looking at our liquidity. We ended the quarter with $1.1 billion of unrestricted cash, which is up $67 million from the end of June. We also had $113 million of restricted cash at the end of the quarter.

Turning to sign-ups. We generated 3,554 sign-ups from 751 communities, which is consistent with our sign-up counts in the third quarter last year. It's worth noting that our sign-ups per community were up approximately 4% in the quarter. However, as expected, our community count was down slightly less than 5% from the prior quarter and the prior year. This is consistent with our earlier estimates of a 5% to 10% year-over-year reduction in our year-end community count. As of September 30, we had 5,143 homes in backlog valued at $1.4 billion, which is down slightly from the 5,345 homes in backlog last year.

Looking at land activity. Quality deals with acceptable returns grow increasingly scarce, but we remain active in the market, having completed transactions in the quarter, securing approximately 2,600 lots.

Going forward, as Richard discussed, we have changed the criteria by which we will evaluate our land investments. In particular, we have amended the method by which we risk adjust the required rate of return for a project. Each project is now rated against a consistent set of criteria that evaluate the risk associated with a proposed project. Factors we consider include the proposed project's deal structure, the time needed for development and build-out, its location and execution risks, including both entitlement and product characteristics. Depending on the results of our assessment, the required internal rate of return of a proposed transaction could range from 20% to in excess of 30%. In connection with this, we will continue to evaluate our existing assets and proposed investments with a view towards improving our returns.

Now I'll cover a few final homebuilder data points. We ended the quarter with 6,763 homes under construction, of which approximately 60% were sold and 40% were spec. Of the spec units, approximately 1,300 were finished, which is down roughly 15% from last year.

Before I turn the call back to Richard, I wanted to take a moment to provide some additional information relating to our mortgage subsidiaries. Many people have asked us for additional information on this topic, including the nature of the loans we've originated and what type of repurchase request activity we're experiencing.

Looking at Slide 9 of our webcast materials, we have broken down our origination for the categories we're routinely asked about, including prime, subprime and miscellaneous other types of mortgages, which includes all brokered, government and bridge loans. It's important to note that the values on the slide represent aggregate origination and do not reflect any repayment, refinance or loan modification activity since the loans were originated. Although we can't quantify how much of the principal has been reduced, it's clear that the unpaid principal balance is likely significantly lower. As you see highlighted, more than 80% of our repurchase requests continue to relate to originations in 2006 and 2007, and we continue to cure or refute more than 60% of the repurchase requests we receive.

I would also point out that we have received an insignificant number of repurchase requests relating to the brokered, government and bridge loans, which represented $14.1 billion of the $39.5 billion of originations in '06 and '07. This means that the pool of originations driving the significant majority of our repurchase requests is $25.4 billion.

Turning to Page 10 and looking at our recent repurchase requests. You'll see that we continue to experience requests in the same consistent range. Although the number of requests is modestly higher in September, it's not clear to us today if this suggests an increase in incident rates or just seasonality given the historical volatility in requests. We will continue to monitor this closely.

As we seek to expand the information we're making available related to our mortgage operations, I would point out that CTX Mortgage issued indemnifications relating to certain loan included in a series of mortgage-backed securities transactions. Under the terms of the indemnification, CTX Mortgage may be required to indemnify the bank for losses incurred by investors in securities due to errors or omissions of information provided to the bank regarding the loans and the origination process.

Two lawsuits have been filed against the securitizing bank related to 2 transactions, which included approximately $162 [ph] million of CTX Mortgage originations. CTX Mortgage has not been made a defendant in the lawsuits, but has been notified of the suits by the bank. We are aware of 6 other transactions where CTX Mortgage made addition to [ph] indemnifications, covering an additional $116 million of originations.

Given the limited dollars involved and CTX' position in this process, we continue to believe these indemnifications will not have a material adverse effect on us. Further, as part of our management of the risks related to our mortgage operations, we have engaged in a thorough assessment of ways to mitigate our risks, including a bankruptcy in certain of our mortgage subsidiaries as a way to eliminate any exposures.

Looking forward, we will continue to challenge each and every exposure item, and we'll seek the best alternative resolution to each issue.

I'll now turn the call back over to Richard.

Richard J. Dugas

Thanks, Bob. Before opening the call to questions, I'll provide a few comments about market conditions during the quarter. On a year-over-year basis, sign-ups in our East area were down about 3%. We continue to see strength in the greater Washington, D.C., and Northern Virginia market, particularly given strong demand for several newer communities we opened in the market earlier this year. We did, however, experience some demand softness in the New England markets much of the summer. We also saw a little softness in Raleigh and Tennessee, which we continue to monitor.

In our Gulf Coast operations, sign-ups were also down 3% for the quarter. Both North and South Florida continue to perform quite well for us. Texas or more specifically Dallas slowed a little as we moved through the quarter. It appears to be a combination of first-time buyers taking a little longer to make a decision and struggling with the challenging mortgage environment. Texas continues to have one of the stronger economies in the country, so we expect this is only a pause, but we'll continue to monitor conditions across all the Texas markets.

Our West area had a solid quarter, posting an increase in sign-ups of 6% over the prior year. In the Midwest, stronger sales in Michigan, Indianapolis and Cleveland offset some weakness in Minneapolis. Further west, the big positive was our Phoenix operations which saw a meaningful pickup in demand, which is particularly important for us given our large presence in that market.

Much of the better resale housing data has been absorbed by investors operating in the Phoenix market, so there's a shrinking supply of quality used homes available for traditional home buyers. Our communities have been the beneficiary of this supply-demand dynamic.

Looking beyond PulteGroup, I would say that overall U.S. housing demand remains stable but at historically low levels. Conditions have not changed very much, with incredible values in home prices and historically low interest rates on one side, balanced against the weak economy, low consumer confidence and tight credit availability on the other.

Within this environment, data continued to tell the story that homeownership remains a critical part of the American dream and that people are still very much interested in buying a home. However, with their investments up 3% one day and down 5% the next because of concerns over sovereign debt impacting expectations about European banks and creating concerns about global liquidity, we can understand their anxiety.

Economic conditions will get better, but in the interim, what we can do is focus on running a better business. And I'm extremely pleased to say that our Q3 results clearly show the success we're having in this regard. Our focus now turns to finishing the year strong, posting another good quarter and continuing to improve our market position heading into 2012.

As always, I want to thank the employees of PulteGroup for their unmatched abilities to deliver quality homes and delighted customers.

Now let me tell the call back over to Jim Zeumer. Jim?

James P. Zeumer

Thank you, Richard. I've been made aware that we are having technical difficulties with our webcast. We will post a copy of the transcript and a copy and link to a replay of this call as quickly as we can when they become available. We apologize for the inconvenience. Evidently, our carrier, our third-party organizers of these calls are having some technical difficulties. We will -- as a consequence, we've asked more people to dial into this call. So I understand there have been some delays, and we will do the best to get to everybody's questions as we can within the time remaining on this call.

So with that, it is time to open the call for questions. So that we can speak to as many of the participants as possible during the time of this call, we ask that you limit yourself to one question and one follow-up.

So with that, operator, we're prepared to open the call if you will explain what needs to get done.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question will come from the line of David Goldberg with UBS.

David Goldberg - UBS Investment Bank, Research Division

My first question, I think it's absolutely great to hear you guys talk about changing the land acquisition model and focusing more on a risk-based model. What I wanted to get an idea about was -- and I appreciate all the detail about kind of what goes in the model. What I didn't hear a lot about was city-specific or market-specific risks, based on what's happening in the market, based on what's driving demand, based on the price depreciation. Maybe you've already seen, if we eventually get into an up cycle at some point. And I was wondering if you can give us some more color about how that would actually work. Would you factor in market-specific risks as opposed to just projects or community-specific risks?

Richard J. Dugas

Yes, David, this is Richard. I alluded to it very briefly in my remarks, but didn't get into a lot of detail on that. Very definitely, we are changing our approach toward allocation to be very specific regarding individual markets, and there's a whole host of factors that we're considering now: macroeconomic conditions in that market, supply-demand dynamic in that market, relative strength for us in that market vis-a-vis others, et cetera, et cetera. So yes, our allocation is frankly more targeted and more rigorous and specific than it has been in the past, which was not as rigorous as that. So you'll hear more about that in coming quarters as we begin to talk more about improving returns in general, but you're exactly on target.

David Goldberg - UBS Investment Bank, Research Division

Well, I think that's great, and looking forward to hearing more about it. My follow-up question, Richard, is if you get to a point where you're now getting better at identifying specific risks and you're better on the cash flow side and the efficiency of the business is helping you turn your cash better, can you make the commitment to being able to return more cash to shareholders when we eventually get into an up cycle? Again, I know it's difficult to see, but I think that's a common criticism that we hear of homebuilding is, there's never a cash really return to shareholders. [Indiscernible] make the commitment?

Richard J. Dugas

Yes, David. I'm sorry. I didn't mean to cut you off. It's a little early for us to talk exactly how we're going to be allocating capital in 2012 and beyond. I would just say stay tuned in that regard. It's not lost on us, that we have consumed or put back most of the cash into the business and that investors might have a different expectation. So I'll punt on that one for now but promise more clarity as becomes available.

Operator

Our next question comes from the line of Michael Rehaut with JPMorgan.

Michael Rehaut - JP Morgan Chase & Co, Research Division

First question on the gross margins. You had some good success there on sequential and year-over-year improvement. And, Richard, in your prepared remarks, initial remarks, I think you identified 4 drivers, those being lower construction costs, increased presale, a rebalance of base versus options and also mix improvement, I think, with perhaps a little more move-up buyer. I was hoping to get a little more granularity in terms of -- if you look at those 4 buckets, and maybe this isn't an exact -- but if even at minimum, just a rough idea of maybe order of magnitude. Among those 4 buckets, what was the biggest drivers of the sequential improvement and the year-over-year improvement?

Richard J. Dugas

Mike, it's fairly well-balanced, and it's very difficult, candidly, to separate it, given all the moving parts and different end markets that are strong like Phoenix versus others that were weaker. I will say that our home construction activities are still in the infancy, and we believe part of our expansion story going forward will be really helped by our focus on construction activities. But beyond that, it's tough to give a whole lot of detail on that. I apologize, but I will reiterate that we expect we can expand margins over the long term from here. We know we've been behind. We're very pleased that we're catching up, and we've got a ways to go yet.

Michael Rehaut - JP Morgan Chase & Co, Research Division

Okay, appreciate it. The second question, I guess, on the exposure with Centex in the prior originations. You mentioned bankruptcy as an option, and obviously, a lot of this stuff is perhaps down the road. But do you have a certain type of cap that you're not willing to go beyond in terms of exposure? And you mentioned a few different lawsuits with -- that were originally Centex originated, I think, a 261 number, 116 number. Can you give us an idea of what would trigger the bankruptcy and what type of overall limit you're trying to create in terms of ultimate gross putback exposure?

Richard J. Dugas

Mike, I don't know that we have an absolute dollar limit in mind. There are a lot of things you have to consider in those relationships with other parties, ongoing business requirements. Obviously, Pulte Mortgage is fully licensed and operating today. We view it as an asset in the closing process, especially in this challenging mortgage market. So again, I think it would be facts- and circumstances-specific. And so if there were issues that affected a particular entity that we felt ultimately our best resolution from all those perspectives was that we would bankrupt it, we would look at whether that made sense. So again, I don't -- the message wasn't, hey, we're looking to do this. It's we are looking to minimize risk across the platform that is mortgage for us, again, given all the sensitivity that we sense in the market and obviously, the exposure that's there. So again, fact- and circumstances-specific.

Operator

Our next question comes from the line of Josh Levin with Citi.

Josh Levin - Citigroup Inc, Research Division

I have a question about mortgage availability. Bank of America is leaving the correspondent lending business. MetLife is leaving the correspondent lending business. So in terms of being able to provide mortgages to your customers, are you feeling any tightness or slowdown in the underwriting and origination process? And is this an issue of concern for you and really the industry going forward?

Richard J. Dugas

Josh, this is Richard. I don't think it's any secret that mortgage availability has been tight for some time. We kind of referenced on our prepared remarks that our Texas markets, particularly for an entry-level buyer, were running up against some headwinds there. Having said that, I don't sense that it's getting worse by the day or anything like that. I think it's been tight for a while. And I wish I could tell you what's going to ease that overall, but it is of modest concern, I would say, and we just are doing the best we can within that environment overall. We're not panicked about it. There are still a lot of qualified buyers out there. It's just that the pendulum has certainly swung to where underwriting criteria are very tight, frankly, in many cases, potentially too tight. We would never advocate irresponsible lending that got this whole industry into a lot of trouble, but I would also say that the pendulum has swung perhaps a little too far.

Josh Levin - Citigroup Inc, Research Division

Okay. My second question is about the graph on Slide 10, the gross loan repurchases request per month. I appreciate what you're saying that the number is pretty low, but when you look at the graph, it is the highest point since '09. It's been trending up. I mean, is your expectation this is just a bounce-around in a range? Or do you think you could actually -- the number is going to go up from here?

Richard J. Dugas

I wish I knew the answer to that question. I would suggest if look at over time, you have seen volatility, peaks and valleys. Certainly, we are seeing in the press just like you that there's a belief that the GSEs are accelerating their process. What we don't know is, is that sustained. Is it just to get through their final book? And maybe more importantly to us is, is it just putting more on the table to talk about as opposed to whether there's more that are problematic. So it could be that there's a lot of paper coming at us and our -- we're able to refute more than we historically have because their perspective is let's take a shot at everything. We'll put everything on the table in front of our counterparty. So I think our view is that it is too soon to tell, and so as we -- obviously, as I mentioned, we're watching this closely. I don't know where this will go, but we're paying attention. But we have to see -- of that September activity, we're working through it now, trying to understand whether there's a consistent risk rate in that for us or if it's diminished by virtue of volume.

Operator

Our next question comes from the line of Ivy Zelman with Zelman.

Ivy Lynne Zelman - Zelman & Associates, Research Division

Richard, maybe give the audience a little color on the recent trip that you participated in. I believe 12 to 13 of the leading builders in America visiting Bernanke and people within the administration and HUD, several others at Treasury and sort of tell us what's on the plate. I know that you guys as a group have been focused on some of the stringencies that are quite extended as it relates to appraisals, also as it relates to credit overlays. But it seems as if Washington's listening again. Is that maybe too optimistic? I mean, can you tell us a little bit about what you're hoping to achieve as a group.

Richard J. Dugas

Yes, Ivy, sure. As some of our audience may not be aware of, the large builders have an association that we formed called the Leading Builders of America. It encompasses approximately 20 of the largest builders in the country, and many of our member CEOs did make a trip to Washington a couple of weeks ago. That's not unusual. We've done that a couple of times a year. And we specifically are focused on 4 things to help the overall housing market that we believe the administration and the government can help with. The first is an expansion and relief of some of the bureaucracy and red tape with regard to the HART program. Our belief is that if we can help underwater homeowners, obviously, these are resale homeowners that are paying on their mortgage, but allow them to potentially refi without appraisals, make the process a lot more streamlined, et cetera, that we can get a lot more of this foreclosure pipeline, that could come at the industry, stopped or stemmed dramatically, and that would help. That was item one we talked about. Two was asking for a review of the independent appraisal process to frankly make it more fair. We've learned that in many cases, appraisals are done by people sitting at a desk and not even visiting a home, so that's a problem. Secondly, we're asking that the process include like-type housing, new housing compared to new or recently resale housing as opposed to, as an example, a foreclosed home that's had the cabinets ripped out, which is maybe not a fair comp. Third, underwriting overlays and standards seem to, as I was alluding to Josh's question, seem to have swung too far. So are there things that can be responsibly done in that regard? And then, fourth would be a reinstatement of the loan limits that were left to expire on October 1. And, Ivy, I would just say overall, the administration and the government was extremely interested, and frankly, we detected a tone of -- a significantly changed tone in regard to their appetite to consider some of these areas. No one's asking for any kind of a handout or direct stimulus like occurred a couple of years ago. We don't think that's responsible. We think these areas could be very helpful, and you saw the president announce something in Nevada earlier this week around HART. We hope that's the beginnings of good things.

Ivy Lynne Zelman - Zelman & Associates, Research Division

Well, it's to hear that they're open again. Would you say that this conforming loan limit increase -- I know that in some cases you mentioned things were softening in some markets. Have you been able to quantify with, obviously, orders having to be written with a lower loan limit back as early as September in order to close or even August? Can you quantify the impact for us on what the conforming loan limit's back to being at a normal levels you've had on your order activity?

Richard J. Dugas

Ivy, our order activity, thus far, in October is relatively consistent with September, and frankly, the dollar impact there for our company specifically is potentially lower than others who have a higher price point. Having said that, the concern we have overall is that it's another kind of weight on housing and particularly from a consumer standpoint, sounds bad. And there's a whole lot of consumer confidence that's kind of on edge here. And it's almost like you got people that are ready to step into the market, but boy, they don't need to hear any additional bad news. But no, I'm sorry. I can't give any granularity to the specific impact of that yet. I just know it's not a positive, unfortunately.

Ivy Lynne Zelman - Zelman & Associates, Research Division

But not a substantial negative?

Richard J. Dugas

I would say, thus far, that appears to be the case for us specifically. I can't speak to any peers.

Operator

Our next question comes from the line of Nishu Sood with Deutsche Bank.

Rob Hansen - Deutsche Bank AG, Research Division

This is Rob Hansen on for Nishu. Just wanted to get your longer-term view on normalized margins and how this has maybe changed with the new capital allocation policy, whether it be you reach it more quickly or maybe it's increased. Yes, I just wanted to get your thoughts on that.

Richard J. Dugas

Yes, Nishu, this is -- or excuse me, Rob, this is Richard. I would say a couple of things. First of all, we do not believe we're at normalized margins yet. We know we have underperformed in that regard. But we're very proud of the progress we've made, and frankly, there's more to come, we believe, in the future. Having said that, there's no doubt that our capital allocation policy should help that. Frankly, we think we're being more responsible with risk-adjusting projects going forward, so that should help. I will point out that it takes time to feather in new land acquisition into the overall closing mix of the company. So it's -- I don't know that you'll see dramatic changes in one specific quarter. But frankly, if you look back, this is the, I don't know, fourth or fifth, sixth quarter maybe in a row we've had reasonably sustained margin growth, and you're likely to see a modest trend, but I don't know. Bob, would you like to add anything to that?

Robert Shaughnessy

Yes. I think one of the things to keep in mind as well is that what we're trying to do is prevent the land from becoming a problem for us, right? So instead of being in these long land positions where we don't get good returns, so what we're trying to do is improve homebuilding margin. So the objective -- the capital allocation doesn't -- it will, I think, lend itself to good margin performance. It wouldn't necessarily be a driver of margin performance. The efficiency of our manufacturing operations will.

Rob Hansen - Deutsche Bank AG, Research Division

Okay. And then -- and I guess on the capital allocation policy, longer term, would we see any shifts in terms of market exposure, getting out of markets or maybe even rebranding in certain markets?

Richard J. Dugas

This is Richard, Rob. I kind of alluded to someone earlier, I think it would be too early to comment on that. What I would say is we're being more rigorous with where we're putting additional capital. We're in the early stages of this re-evaluation to be more rigorous. Probably the best way for you to think about it is we're not going to invest at nearly the same rate in markets going forward, frankly, because they don't offer the same opportunity. But that also considers our existing position in that market. We know that we, frankly, are a lot more efficient where we're large in a given market and not as efficient where we're not. So we're going to take that along with a number of other factors into account for future acquisitions, but that's as much as we want to say about that at this point.

Operator

Our next question comes from the line of Joel Locker with FBN Securities.

Joel Locker - FBN Securities, Inc., Research Division

Just one question. I don't know if I missed it or not, but what was your total spec count at the end of the third quarter and finished also?

Richard J. Dugas

Sure. Total spec count was 2,886, and of those, 1,318 were finished on the spec side.

Robert Shaughnessy

We said that finished was down from prior year 15% -- about 15%, yes.

Operator

Our next question comes from the line of Ken Zener with KeyBanc.

Kenneth R. Zener - KeyBanc Capital Markets Inc., Research Division

I wonder if you could explore -- you obviously had a lot of success, I think, in your SG&A margin. For us, that was in part due to higher volumes that you had in the quarter. So it seemed like you had a higher conversion, whether, you're looking at units under construction or backlog. Could you look or talk about that, A? And B, it looks like your fixed G&A expenses also dropped pretty solidly sequentially. Is that a -- could you kind of talk about where you are in your fixed G&A versus assuming your variable costs are around 5%?

Richard J. Dugas

Ken, I'll start and then throw it to Bob. This is Richard. Not only did our leverage improve because of volume, but our total dollar spend went down pretty dramatically, about $150 million over the past year. So I'd just offer that. And then, Bob, beyond that, in terms of additional SG&A color, fixed versus variable.

Robert Shaughnessy

No. I think what you see in this quarter is, I think, entirely consistent with what we talked about last quarter. So if you trend it out into fiscal '12, we think that we're running at or near where we thought we would after all the actions taken earlier this year and earlier the year before.

Kenneth R. Zener - KeyBanc Capital Markets Inc., Research Division

Okay. You'd mentioned for gross margins that you -- the move-up product had -- that was one of the contributors. Could you talk to what you're seeing, I guess, entry versus the move-up in the case you cited as well as if you're improving your cycle time, if that's what contributed to the higher conversion rate, whether it be units under construction or backlog in the quarter?

Robert Shaughnessy

Well, we are seeing improvement in margin in the move-up sector. We are also seeing that be a larger proportion of our business, so that clearly is a driver of our margin improvement. I hope that answers your question.

Richard J. Dugas

And maybe just to clarify it for you, I mean, our margins in the Pulte brand are historically higher than the Centex brand. So anytime you get a change in that mix, you'll get some benefit from that.

Operator

Our next question comes from the line of Stephen Kim with Barclays.

Stephen Kim - Barclays Capital, Research Division

I wanted to ask you a couple -- one question about your new policy towards capital allocation and the other one about the -- unfortunately, about this putback issue. Regarding your new methodology by which you're going to be evaluating investments, I think you also indicated that you were going to be taking a fresh look at existing assets. And by that, I assume you mean properties that you already own, that you're in and so forth. And I guess what it brings to my mind is, is there any likelihood or possibility that as a direct result of what you're doing here, that we may see something different in terms of your perceived impairments that will need to be taken? Or is there something about the way you're looking at things that would cause that to be sort of reassessed in a significant way?

Robert Shaughnessy

Well, I think at the end of the day, what we're trying to do is look through the balance sheet with the same lens that we're looking at future spend, so I think it is -- in terms of impairment, we have a community-specific process that we followed this quarter just like we followed the quarter before. Impairment risk there is going to be if pace slows. And I think as we've talked about in the past, we wouldn't expect to see, absent some structural change, significant declines in volumes, significant declines in average selling prices for there to be broad-based impairment. So again, for us, what would happen is, is as we look at particular assets, if we changed our intent with respect to those, we could see some impact in impairment activity.

Stephen Kim - Barclays Capital, Research Division

Okay. And then to follow up regarding your putback slide. Again, you put out the slide, and of course, it brings up a lot of questions, unfortunately. But as we look at this, not only do we see that it sort of moved up a little bit, but it makes us wonder a little bit about whether the constitution of, or the -- yes, really, the kinds of loans that you've seen put back to you, if that's been changing at all. So I was wondering if you could talk about that. And then also, in your answer to Josh's question, I just want to make sure, what are you assuming the rate of putbacks will do over the course of the next few years? Can you give us some sense of how you're looking for this rate to trend down in the reserves that you've taken thus far?

Robert Shaughnessy

Sure. I think I'll answer the second question. Because I think the answer is the same as what we talked about at the end of the second quarter. The expectation is that there will be a decline in these types -- this level of request between now and the end of fiscal '12, so call it 15 months from now. What we need to do is assess whether that will -- if that's still an appropriate assessment. Again, the way we had it planned out was through the back half of this year till the end of the year, we would see continued activity consistent with what we see today. So we haven't seen anything that changes our view on that, but we'll have to assess it as we go forward, do we see an increase in incident rate or severity in terms of the stuff that's coming at us and whether we think it has a longer tail than that.

Richard J. Dugas

To his first question, in terms of the composition of what we're seeing. No change in that, just the overall volume increase, correct?

Robert Shaughnessy

Right. We haven't provided data on that. But in broad terms, no, we haven't seen a change in the composition of what's coming to us.

Operator

Our next question comes from the line of Stephen East with Ticonderoga Securities.

Stephen F. East - Ticonderoga Securities LLC, Research Division

If we can talk a little bit more about the putbacks. You mentioned a variety of things: one, potential bankruptcy, et cetera. I guess, first, could you talk a little bit about the mix between how much of this was coming from Centex and how much of it was coming from the Pulte financial services? Because I'm wondering could you really -- how hard would it be to pierce the corporate veil if you filed for bankruptcy if a lot of this was coming through the Pulte operations?

Robert Shaughnessy

Well, again, we haven't historically commented on that, and I would suggest we'll continue to view this externally as a combined issue. Piercing the veil, again, I think each and every circumstance is different. And so as I mentioned to the question earlier, if we get to a point where we think bankruptcy is the best answer for a particular entity, we would look at it. Again, using Pulte as the example, again, it's our active captive mortgage company. We are interested in continuing that relationship, so we'd have a real hard time looking at that. So again, it's going to be circumstances driven. So again, piercing the veil or not piercing the veil is a legal question.

Stephen F. East - Ticonderoga Securities LLC, Research Division

Okay. And then these are all originations. Is there a way for you to get your hands on how much has already been either refi-ed or cured or et cetera, so you have an idea of -- a better handle on what could be the potential gross exposure? And then the second thing is Lennar and a few others have looked at global settlements with some of the banks. Was your business concentrated enough for you all to be able to go down that path as well?

Robert Shaughnessy

Yes. I'm going to tell you -- again, we've said we're looking at all avenues to mitigate risk. Certainly, settlement would be one, and it may be the most expedient, candidly. So I think we will look at that. Forgot the first part of your question.

Stephen F. East - Ticonderoga Securities LLC, Research Division

Unpaid balance.

Robert Shaughnessy

Oh, unpaid balance, yes. It's hard for us to get that. We've tried to get anecdotal data, and clearly, there has been fairly significant decline, in a lot of this with the changing interest rate.

Since then, many people have been able to and have refinanced their loans. People have sold their homes and moved, but again, we don't have any hard data on that. So we don't want to speculate for you.

Operator

Our next question comes from the line of Adam Rudiger with Wells Fargo Securities.

Adam Rudiger - Wells Fargo Securities, LLC, Research Division

I wanted to ask one more question on the capital allocation, and you mentioned more than once the desire for quick returning assets. And I'm curious what implications that has for the Del Webb business, which tends to carry larger, bigger pieces of land.

Richard J. Dugas

Yes, Adam, this Richard. I think a couple of things. First of all, I think from an underwriting criteria of future acquisition in the Del Webb space, we have a much higher return threshold required because of the long nature of the asset. Bob indicated a previous policy where we had like a 21% IRR hurdle for everything. Now it's spanning 20% to well north of 30% in total. So I think the answer would -- we'd be more rigorous with regard to our assessment of a Del Webb project. It doesn't mean we won't pursue a Del Webb project. Frankly, it's a very good performing part of our business, but we'd just be very selective with regard to land regarding it. I think the second component is it's likely that the majority of our projects going forward in that regard might be smaller. We have a sizable number of 8,000-, 9,000-lot projects today, and I think those are going to be harder to come by with the new allocation process. But the brand itself and the focus on active adult is very well served in many 1,000-lot communities, 1,500-lot communities, and that could well be more of a model for us going forward. So we'll have to see how it plays out, but that would be what I would say directionally. Bob?

Robert Shaughnessy

Yes, again, obviously deal structure matters. So as we look at some of the longer-term projects, we have to work with developers or land sellers in a way that can make sure we have access to the property for that return and risk profile to make sense to us.

Adam Rudiger - Wells Fargo Securities, LLC, Research Division

Second question is just following up on one of the SG&A questions earlier. I wanted to ask it another way. Just how much of the $125 million in targeted cost savings are completed? Are we seeing it in this quarter's SG&A?

Richard J. Dugas

That's substantially all of it, but if you annualize what we saw this quarter, it would come out to a rate consistent with what we had suggested you would see.

Operator

Our next question comes from the line of Bob Wetenhall with RBC.

Robert C. Wetenhall - RBC Capital Markets, LLC, Research Division

Just wanted to touch on Richard's comments about incremental upside in gross margins from reducing construction cost. I was hoping you could put a -- provide some guidance in terms of the time frame and how much can you think you can improve that.

Richard J. Dugas

Yes, Bob, a couple of things there. When we started really aggressively talking about this, I'd say 6 to 12 months ago. We said it was a 3- or 4-year journey to get where we want to be, and we still believe that. So I have to still think we're in the early innings particularly of that component of margin expansion on the house cost side. There's a lot of work that goes in when we attack costs in an individual set of floor plans. It takes a while for the closings to actually occur from the work we did, say, 6 months ago, overall. So it's -- that's why I kind of described it as more of a slow, steady march as opposed to a step change in any one quarter. And then, of course, mix can impact margins in any one quarter specifically as well. But I would say, over the long term means over the next 2, 3 years, it's going to take to get us where we want to go. Having said that, we're pleased with having closed the gap with some of our peers to this point.

Robert C. Wetenhall - RBC Capital Markets, LLC, Research Division

Got it. That's pretty impressive. On the new order trends, you were flat against pretty easy comparisons last year, and it looks like you have a very easy comp for new orders in 4Q. Are you expecting to comp substantially positive in the fourth quarter? Can you just give some guidance on what you're seeing traffic-wise since the end of the quarter?

Richard J. Dugas

I'll say a couple of things about sign-ups. First of all, we're pleased with our sign-up performance, actually, very pleased. When you -- if you can appreciate where this company is -- and I'm not -- and I'm specifically contrasting that versus some of our peers. Margin improvement, SG&A leverage and frankly, asset turns are a lot more important than volume growth for us at this point. If we were sitting at 23% adjusted margins, it might be a different story. But where we are today, we have the organization keenly focused on that, so I would suspect that our year-over-year comps might not equal what you see from some of our peers who are growing community count. But frankly, as I think you also see from a couple of our peers just from the last week, that doesn't necessarily translate into profitability without the other components, and so we're very pleased with the trajectory we're on. Community count will definitely play a part in that, and as Bob indicated, we had expected this year to be down 5% to 10%. We're going to be down 5% to 10%. So again, that's as far as I'll go in terms of what we expect in Q4. In terms of traffic levels, like I indicated, I think, earlier to Ivy, they're reasonably flat with what we saw in September, and candidly, we'd say that seems about right seasonally.

Operator

Our next question comes from the line of Mike Widner with Stifel, Nicolaus.

Michael R. Widner - Stifel, Nicolaus & Co., Inc., Research Division

Most of my questions have been answered. Let me just -- quick follow-up. Not sure how to answer this one from you guys. But in all your conversations that you alluded to with the government and the administration, I think you talked about a number of things that we've heard the government talk about some of what you're -- look to be getting put in place. But some of the obvious things that have been holding back the market are just the pressures from the administration themselves. I mean, the FDIC suing the appraisers certainly isn't helping the appraisal situation and the just consistent regular demonizing, suing, and strongarm tactics with the banks isn't going to help the banks ease up on lending standards when nobody wants to be the guy showing the worst metrics on the street. So everyone wants to cut off the bottom into the lending pool. Any sense of that? Any conversation about that? Any sense that the government might recognize that it collectively has really been part of the problem thus far?

Richard J. Dugas

Yes, Mike, this is Richard. I can't comment specifically on that because frankly I didn't hear about any of that specifically, and we didn't address that directly. I will echo, though, that there was a notable desire on the part of the administration to be very interested in housing and concerned about housing, and I think I would speak for my peers in saying it's about time. And that sounds right. So yes, I mean 65% of people in this country, roughly, own a home. We know that until home values stabilize and improve, that the economy is going to be held back. I think the administration realizes that, and is -- seems to be receptive to working on it. So I can't comment as to whether or not that'll impact the specifics you talked about, though.

Michael R. Widner - Stifel, Nicolaus & Co., Inc., Research Division

Yes. I mean, hopefully, they'll embrace it. Sometimes do no harm is a more effective policy than trying to stick your fingers in everything. I guess, just one other follow-up question about the capital structure and capital allocation. Obviously, you guys are running with, relative to peers and relative to history, a bit higher net debt to total cap. And as you think about the land supply and land investments and capital allocation going forward, do you have any particular net debt to total cap, or however you want to think of it, capital structure in mind going forward and either directionally or a target that you're marching toward?

Richard J. Dugas

I would say that we'd like to drive the net debt to cap more favorable from where it is. We don't want to keep it this high. Beyond that, we'll have more to say in coming quarters about how we intend to get there. I don't know, Bob, if you want to comment any further.

Robert Shaughnessy

No. I think the message is exactly right. We would want our net cap rate going down from here.

Operator

Our next question comes from the line of Jay McCanless with Guggenheim.

James McCanless - Guggenheim Securities, LLC, Research Division

My first question on the mortgage putback provisions. In the first quarter, there was an increase in requests for information, and then a quarter later, we saw an increase in your provision. With the spike that we're seeing in the third quarter, should we expect a similar increase in the provision for the fourth quarter?

Robert Shaughnessy

I don't know that they're causal in that particular case. Again, what happened was the original accounting looked to an end date that we concluded wasn't appropriate. It wasn't because of an increase in that time. It's just that it hasn't declined like we thought it would. And so I think if you were to extend this line out at the September rates, again, I think we would have to rethink when this would end, but a lot of things would play into that. What's the severity? How much can we actually refute? So a lot of things go into this. We've summarized it on one slide with a line. But there are different inputs and variables that influence the accounting.

James McCanless - Guggenheim Securities, LLC, Research Division

Okay. And my second question, with the discussion about bankruptcy, could you give a little more specificity around which entity you potentially could bankrupt? And would there be any cross default issues with the other portions of Pulte? And what do you think -- and have you had any discussions with the rating agencies? And what do they have to say about the potential for this action?

Robert Shaughnessy

Yes, I want to close it down just a little bit. We are not suggesting that we are going to bankrupt anything. We're just saying that in the alternatives available to us, it is one, and it is the -- it has lots of consequences, so we would want to weigh those very carefully. So clearly, we have not talked to the rating agencies. In terms of the cross default, again, entity by entity, we might have a different answer, but generally, we don't. We do not have cross default provisions between the mortgage entities and the parent. So on a technical level, I don't think we would have an issue with that. But again, just trying to suggest we're focused on risk as opposed to we're going to bankrupt something.

Operator

Our next question comes from the line of Alex Barron with Housing Research Center.

Alex Barron - Agency Trading Group

I guess it was good to see the impairment issue get behind you guys on the goodwill, but I was wondering about the intangibles component. How or why is that treated differently? And why wasn't that impaired as well?

Richard J. Dugas

Yes, the intangibles on our books, remaining on our books, are the value of the trade names that were acquired in the Centex and Del Webb acquisitions. They do have -- we do have a requirement to assess those for impairment. It is predicated on undiscounted cash flows, and we think, based on the modeling for the business, that there are sufficient cash flows to do that with a fair amount of cover, actually. So just a little bit different standard in terms of how you actually apply the impairment assessment. Following GAAP, we think we've got cover on both those assets.

Alex Barron - Agency Trading Group

Got it. And on your SG&A, nice job in cutting it there. Was there any onetime or other factors that might turn the other way next quarter? Or is this a kind of a good run rate way to think about it?

Richard J. Dugas

Alex, it's a result of the work we did in '10 and earlier this year, and as Bob indicated, we kind of think this run rate is approximately where we're going to be on an annualized basis. So I don't want to comment on what could happen 5 quarters from now or something like that. We don't know what the business is going to bring, but right now, we're not forecasting any onetime increases.

Operator

Our next question comes from the line of Steve Stelmach with FBR Capital Markets & Company.

Steve Stelmach - FBR Capital Markets & Co., Research Division

Not to belabor the bankruptcy talk, but sounds like you guys are talking more about evaluating a legal implication. But could you give us a little bit of color on how you guys are evaluating the implications for your cost of capital for the homebuilding business, if that may be an avenue you guys would entertain?

Richard J. Dugas

I'm sorry. The question -- have we thought about what impact it would have on our cost of capital if we did or did not bankrupt the business?

Steve Stelmach - FBR Capital Markets & Co., Research Division

Yes, and maybe you could give us a little bit of color on the approach you guys are thinking about in terms of how that may impact...

Robert Shaughnessy

No, not really. Again, we are, in the short term, not in the capital markets at all. So I think it's a conversation. I think our business results will drive the cost of capital more than that issue.

Operator

Our final question will come from the line of Susan Berliner with JPMorgan.

Susan Berliner - JP Morgan Chase & Co, Research Division

Just one question, I guess, on the land market. I know you guys had said that it's a little bit harder to pencil the deals, and I was wondering what was really driving that. And also, I know you guys don't give specific guidance on land acquisition or development. Can you give any more color? Should we just expect more development going forward than land acquisitions? Or are there certain markets that are penciling out a little bit better than others?

Richard J. Dugas

Yes, Sue, this is Richard. I think frankly, the land market's consistent with what we've talked about in the past. I mean, the finished lots that are very return friendly are largely picked over, the A locations. So that's why the total land market is tight. And frankly, until you get a little bit of a rebound in the business, other assets that you're looking at are harder to pencil. Having said that, I do think we indicated that we did transactions in the quarter, totaling about 2,600 lots overall. So we're not out of the market, and our new capital allocation criteria is weighing in with regard to those acquisitions, so we're pleased with that. So with regard to spend going forward, clearly, with the large land bank, a good portion of our spend will be on developing our existing assets and driving better returns from those. But having said that, I don't know that there's any dramatic shift that you should look at for us with regard to mix anytime soon. All we're trying to say is that the land market is not transacting a tremendous amount of volume right now, and we're okay with that. We have a large land bank. It's much more important for us to drive margins and SG&A than to be in the land market, and we don't want to get too aggressive on acquisition only to have a problem.

Susan Berliner - JP Morgan Chase & Co, Research Division

Got it. And one other question. And sorry to belabor the point on the whole bankruptcy issue. I guess within the Centex mortgage operation, were there various subsidiaries, like you have in Pulte, in homebuilding Pulte, that only one entity within that Centex mortgage could be filed for bankruptcy? Or can you just give us a little color on that structure?

Richard J. Dugas

Well, without getting into specifics, every corporate structure typically has multiple entities addressing different things. So that would be what we're looking at.

Operator

Due to the time restraints, we will now conclude our Q&A session. I would now like to hand the presentation back over to management for closing remarks.

James P. Zeumer

This is Jim Zeumer. We will be available for questions throughout the day. So certainly feel free to call. Before we end the call, I know Richard wanted to make a couple of other comments.

Richard J. Dugas

Yes. Just one final remark I'd like to make. Before we sign off, I'd like to take a second to mention just how proud I am of our people for their hard work in returning the underlying operations to profitability in the third quarter for the first time for our company in about 5 years. Slugging it out for this long a period makes this quarter's results all that much sweeter, and we believe we're just getting started on a road for improvement. Thanks to everyone for their time on the call today, and have a great day. Thank you.

Operator

Thank you for attending today's conference. This concludes the presentation. You may now disconnect, and have a great day.

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