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Pulte Homes, Inc. (NYSE:PHM)

Q3 2007 Earnings Call

October 25, 2007 8:30 am ET

Executives

Calvin Boyd - Vice President, Investor and Corporate Communications

Richard J. Dugas - President, Chief Executive Officer, Director

Roger A. Cregg - Chief Financial Officer, Executive Vice President

Steven C. Petruska - Executive Vice President, Chief Operating Officer

Vincent J. Frees - Vice President and Controller

Analysts

Michael Rehaut - J.P. Morgan

Nishu Sood - Deutsche Bank

Phil Drummer - Merrill Lynch

Timothy Jones - Wasserman and Associates

Stephen Kim - Citigroup

Alex Barron - Agency Trading Group

David Goldberg - UBS

Susan Berliner - Bear Stearns

Dan Oppenheim - Banc of America Securities

Carl E. Reichardt, Jr. - Wachovia Securities

James Wilson - JMP Securities

Dennis McGill - Gillman & Associates

James Mccanless - FTN Midwest Securities

Stuart Hosansky - Vanguard

Operator

Good day and welcome to the third quarter 2007 Pulte Homes earnings conference call. My name is Carol and I will be your coordinator for today. (Operator Instructions) I would now like to turn the call over to Mr. Calvin Boyd. Please proceed, sir.

Calvin Boyd

Thank you, Carol. Good morning and thank you for joining us to discuss Pulte Homes financial results for the three and nine months ended September 30, 2007. I am Calvin Boyd, Vice President of Investor and Corporation Communications. You’ve all had a chance to review the press release we issued last night detailing Pulte's third quarter 2007 operating and financial performance. On the call to discuss these results are: Richard Dugas, President and Chief Executive Officer; Steve Petruska, Executive Vice President and Chief Operating Officer; Roger Cregg, Executive Vice President and CFO; and Vinnie Frees, Vice President and Controller.

For those of you who have access to the Internet, a slide presentation available at www.pulte.com will accompany this discussion. The presentation will be archived on the site for the next 30 days for those who want to review it at a later time.

As with prior conference calls, I want to alert everyone listening on the call and via the Internet that certain statements and comments made during the course of this call must be considered forward-looking statements as defined by the Securities Litigation Reform Act of 1995. Pulte Homes believes such statements are based on reasonable assumptions, but there are no assurances that actual outcomes will not be materially different from those discussed today.

All forward-looking statements are based on information available to the company on the date of this call and the company does not undertake any obligation to publicly update or revise any forward-looking statements as a result of new information in the future.

Participants on today’s call should refer to Pulte's annual report on Form 10-K for the year ended December 31, 2006, and subsequent Forms 10-Q for a detailed list of the risks and uncertainties associated with the business.

In addition, this call may refer to certain non-GAAP financial measures. For a reconciliation of these measures, please see the slide presentation that accompanies this discussion. As always, at the end of our prepared comments, we will have time for Q&A. We will wait until then before opening the queue for questions.

I will now turn over the call to Richard Dugas for his opening comments. Richard.

Richard J. Dugas

Thank you, Calvin and good morning, everyone. The operating environment for home building has been difficult for some time now and our third quarter proved to be a challenging one as well. The inventory of new and existing homes continues to be elevated, cancellation rates remain high, and prices of new homes are still under pressure, all having a negative impact on already low buyer confidence.

In addition, concerns surrounding tighter lending standards and ongoing impairments and land related charges pushes any signs of stabilization further away.

Our third quarter 2007 net loss was due largely to sizable impairments and land-related charges, along with good will impairments taken during the period. These charges result from a weak pricing environment in most major markets in which we operate. We will cover these charges in more detail during Roger’s prepared comments.

However, in the midst of this challenging environment, Pulte was able to make substantial progress in the following key areas: we generated a profit from continuing operations before consideration of impairments and land related charges. The profit realized exceeded the upper end of the guidance we provided during our second quarter earnings call. We consider that an important accomplishment in such a challenging environment as this.

In our third quarter, there was approximately $175 million of net cash generated by the company, another very important accomplishment that we are proud of. Our goal was to sell and close homes at reasonable prices to generate cash and we accomplished that. In addition, despite the very weak operating environment, our operators are doing an outstanding job of closing homes and managing land acquisition and development spending, allowing us to project approximately $1 billion of cash on hand by the end of the fourth quarter this year. Roger will have more details in a moment.

Our backlog at the end of the third quarter stood at 12,000 units, valued at just over $4 billion, the best among public home builders who have reported to date.

During our second quarter of 2007, we announced a restructuring plan designed to reduce SG&A costs and improve operating efficiencies to match the current demand environment for housing. Our progress is evident, as our SG&A spend in the third quarter was approximately $65 million lower than the same period last year.

We were pleased with our progress on SG&A and are on track to meet the targeted savings we announced earlier this year.

We stated in our prior earnings call that our immediate goal during this downturn was to return our core operations to profitability, excluding any impairment in land-related charges. Pulte accomplished this in the third quarter, and as you saw in our press release, we are also projecting a modest operating profit in the fourth quarter, again excluding any impairment in land-related charges.

During the third quarter, we again lowered pricing in many of our markets in order to move inventory. Although this strategy achieved some success, we feel that in several cases, lower pricing is not necessarily generating additional sales volume. Therefore, moving forward, we are reducing pricing and using incentives only in limited cases where we feel that will result in more sign-ups leading to closings and incremental positive cash flow, mostly for communities with substantial inventory on the ground.

At this point, in a few cases we feel we are better mothballing communities or not putting incremental cash in where it is not needed, versus continuing the downward price spiral.

On the house inventory front, we continue to work toward lower spec inventory levels. Despite this focus, spec levels remain relatively flat during the quarter, as cancellations ticked up noticeably given the mortgage turmoil so widely reported.

We remain committed to keeping house inventory levels low. On the land front, we once again reduced our level of controlled lots, again with the goal of reducing inventory while navigating through this downturn. Our short-term goals remain focused on properly managing inventory, having SG&A expenses match the current demand environment, maximizing sales, and overall balance sheet strength.

Pulte's restructuring efforts have led to a leaner overhead position that will continue to benefit us going forward. Pulte's backlog position remains relatively strong going into the fourth quarter, and combined with our overhead reductions, serves as the basis for our fourth quarter guidance, similar to our thinking behind our third quarter guidance.

We will continue to focus on reducing inventory levels, particularly spec inventory, with cash generation as the primary goal.

Time has proven that no one can be sure when this particular downturn will end or begin to show signs of stabilization. Since we are not sure how long this environment will stay this bad, Pulte plans to be prepared for the worst. We are staying committed to our short-term goals, ready to adjust our tactics as needed to navigate through this tough environment.

Demographic trends, household formations, and population growth are the factors that will eventually bring back housing to more attractive levels and help sustain positive operating performance. Pulte plans to be one of the major builders that will thrive during that time period.

Finally, let me take a moment to thank our Pulte employees who are doing a remarkable job operating in the worst housing recession in memory. Your dedication, commitment and attitude are outstanding and deserve my heartfelt thanks. I am proud to work alongside each of you.

Thank you and now let me turn the call over to Roger Cregg. Roger.

Roger A. Cregg

Thank you and good morning. The third quarter home building net new unit order rate decreased approximately 37% from the third quarter last year, on 7% less communities versus the same quarter last year.

Revenues from home settlements from the home building operations decreased approximately 31% from the prior year quarter to approximately $2.4 billion. Lower revenues for the period were driven primarily by the lower unit closings that were below prior year by approximately 28%. The average sales price decreased approximately 4% versus the prior year quarter to an average of $322,000 per home.

In the third quarter, land sales generated approximately $31 million in total revenues, which is an increase versus the previous year’s quarter of approximately $16 million.

Home building gross profits from home settlements, including home building interest expense for the quarter, decreased approximately 149% to a loss of approximately $293 million. Third quarter home building gross margins from home settlements as a percentage of revenues was a negative 12.2% compared with 17.1% in the third quarter of 2006.

The decreased margin conversion versus the prior year quarter is attributed to land and community valuation adjustments, in addition to increased selling incentives. Adjusting the current quarter for land and community valuation charges, the gross margin from home settlements as a percentage of revenues was at a run-rate of approximately 13.4% for the quarter.

The third quarter benefited from the impact of prior quarters land and community valuation adjustments by approximately 150 basis points, or $36 million.

Additionally, home building interest expense increased during the quarter to approximately $98 million versus approximately $65 million in the prior year. Included in the interest expense of $98 million is an additional $43 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 $572 million. For the third quarter, we tested approximately 245 communities for potential impairment and valuation adjustments. We recorded valuation adjustments on approximately 169 communities for the third quarter.

The total gross loss from land sales posted for the quarter was approximately $79 million. The loss is mainly attributed to the fair market value adjustment in the current quarter for land being held for disposition in the amount of approximately $80 million, which is included in the land cost of sales.

The gross profit contribution from specific land sales transactions were approximately $1 million for the current quarter. Land sale transactions during the quarter included single family custom lot sales, along with residential and commercial land parcels.

SG&A expenses as a percentage of home sales for the quarter was approximately 9.8%, an increase of approximately 180 basis points over the prior year quarter. Additionally, the current quarter also included an insurance reserve related charge of approximately $20 million associated with the development of general liability product claims based on an actuarial basis. This additional charge in the third quarter represented approximately 83 basis points in conversion.

As Richard mentioned, we reduced our overhead spending in almost every category, yielding a gross reduction of approximately $62 million versus the prior year quarter before the additional non-cash insurance reserve adjustment, netting approximately a $43 million reduction versus the prior year quarter.

In the other income and expense category for the quarter, the expense of approximately $490 million includes the write-off of land deposits and other related costs of approximately $95 million associated with land option contracts that we determined not to exercise.

Additionally, a valuation adjustment of approximately $51 million related to certain investments in unconsolidated joint ventures, and approximately $7 million in restructuring charges related to our overhead restructuring initiatives implemented in the second quarter.

Also in included in the quarter is an impairment charge related to good will of approximately $336 million. In accordance with statement of financial accounting standards number 142, we determined that as a result of the current market conditions, our book value exceeded the fair value in a number of our reporting segments, resulting in the impairment of good will.

Recapping the components of the $1.178 billion in impairments in land related charges for the third quarter, we have included in the webcast a slide breaking out the charges by the categories I discussed and by reporting segment.

Additionally in the third quarter, we dropped land options representing approximately 8,400 lots with a purchase price value of approximately $669 million.

The home building pretax loss for the third quarter of approximately $1.099 billion resulted in a pretax margin of approximately a negative 45% on total home builder revenues.

Excluding the charges related to the valuation adjustments in land inventory and investments, land held for sale, the write-off of land deposits and other related costs, good will and restructuring charges, home building pretax margins converted at approximately 3.2% for the current quarter.

At the end of the third quarter, our home building operations had a backlog of 12,042 homes, valued at approximately $4.1 billion, compared to 16,375 homes valued at $5.8 billion as of the prior year quarter.

The third quarter pretax income from Pulte's financial services operation was approximately $13 million, or a decrease compared with the prior year quarter of approximately $8 million. The decrease is mainly attributed to lower revenues from decreased volumes, offsetting a favorable product mix shift to higher profit loans and an increase in the capture rate. The favorable shift to agency versus non-agency products during the quarter resulted in greater profits due to higher servicing values and better structured guidelines allowing greater leveraged processing efficiencies in the operation.

The level of adjustable rate mortgage products originated during the third quarter of 2007 decreased from approximately 26% of origination dollars funded from our warehouse line in the third quarter of the previous year to approximately 7% this quarter.

Pulte Mortgages capture rate for the current quarter was approximately 93%. Mortgage origination dollars decreased in the quarter by approximately $731 million, or 34% when compared to the same period last year. The decreases related to the overall volume decrease in home builder closing activity for the quarter.

In an analysis of our loans closed for the third quarter, based on dollars, we estimate that approximately 4% of the loans with an average FICO score of 588, fell into the sub-prime category. Additionally, 85% fell into the prime category, with an average FICO score of 746, and the remaining 11% in the category of Alt-A product, with an average FICO score of 754.

Overall, the average FICO score of our loans closed for the period was 740, with 83% of the loans averaging a FICO score greater than or equal to 681. This is consistent with our analysis performed for the first half of this year.

In the other non-operating category, pretax loss for the third quarter of approximately $8 million includes mainly corporate expenses of approximately $8 million. The net loss for the third quarter was approximately $788 million, or a loss of $3.12 per share, as compared to net income of approximately $190 million, or $0.74 per diluted share for the same last year. The number of shares used in the EPS calculation was approximately 252.3 million shares for the quarter.

On the balance sheet for the third quarter, we ended with a cash balance of approximately $102 million, increasing $27 million from the second quarter of this year. House and land inventory ended the quarter at approximately $8.1 billion.

Excluding the inventory adjustments for the third quarter, total inventory decreased approximately $340 million from the second quarter. House inventory, excluding land for the quarter, increased approximately $43 million, related to the seasonal increase in home construction in progress.

Land inventory during the third quarter, excluding adjustments, decreased approximately $380 million as land relief offset rolling lot option take downs and land development spending.

After generating $175 million in net cash during the third quarter, excluding financial services, we paid down $148 million on our revolving credit facility and remain with $25 million outstanding on the facility at the end of the quarter. The company’s gross debt-to-cap ratio was approximately 40.3% and on a net basis, 39.6% for the third quarter.

Interest incurred amounted to approximately $62 million in the third quarter, compared to $73 million for the same period last year. Multi-home shareholder equity for the third quarter was approximately $5.2 billion. We repurchased no shares during the third quarter and the company has approximately $102 million remaining on our current authorization.

Now, looking forward to the next quarter and under the SEC regulation FD guidelines, we provide the following guidance on our current expectations and projections for the fourth quarter of 2007.

Fourth quarter earnings per share are estimated to be in the range of approximately a break even to $0.10 per diluted share. This range does not include the potential for additional land valuation adjustments, option deposit, and other related charges, or additional good will impairment charges. Although we may incur additional write-offs, it is uncertain at this time as to the estimate of those amounts. This earnings per share number is calculated based on approximately 258 million fully diluted shares.

Unit settlements in the fourth quarter of 2007 are projected to be approximately 14% to 15% above the second quarter of 2007 deliveries -- excuse me, the third quarter of 2007 deliveries. Again, that’s 14% to 15% above the third quarter.

Average selling prices for the closings in the fourth quarter are estimated to be approximately $327,000. The projected average selling price is primarily being driven by product and geographical mix, as well as the additional incentives for homes projected to be delivered during the fourth quarter.

Gross margin performance from home settlements as a percent of sales for the fourth quarter are anticipated to be in the approximate range of 10% to 11%. The projected gross margins for the quarter primarily reflect pricing strategies generating sales momentum and pricing incentives experienced over the period, in response to the market conditions for homes to be delivered.

In addition, this gross margin range includes an estimated 150 basis points improvement from the recovery of additional inventory valuation adjustments taken in the third quarter of 2007.

We are currently projecting no land sale gains for the fourth quarter.

As a percentage of sales, SG&A is expected to be in the range of approximately 9.3% to 9.6% for the quarter.

In the home building other income and expense category for the fourth quarter, we are projecting expense of approximately $6 million to $7 million. Pretax income in our financial service operation is expected to be approximately $12 million to $14 million for the fourth quarter.

Total other non-operating expenses are projected to be approximately $13 million to $14 million for the fourth quarter.

We are projecting the effective income tax rate to be approximately 37% for the fourth quarter of 2007. Given the continued uncertainty in this challenging market environment, and the lack of visibility to look beyond the quarter, we are offering no full year outlook for 2008 at this time. We will continue to assess the conditions through the next quarter and provide an update accordingly on our fourth quarter conference call.

As I’ve mentioned over the course of this year, with respect to our goals in timing and cash management, we continue to target ending the year with a cash position of approximately $1 billion, less any senior debt repurchases completed.

Additionally, we anticipate no outstandings on our revolving credit facility at year-end. We have continued to focus on reducing our land pipeline, generating cash, and are committed to maintaining a solid and flexible balance sheet.

Now I will turn the call over to Steve Petruska for more comments on the operations for the third quarter. Steve.

Steven C. Petruska

Thanks, Roger, and good morning, everyone. As Richard noted, continued high inventory of new and existing homes, tighter mortgage liquidity, and weak consumer demand were factors that contributed to the difficult operating environment we experienced in the third quarter. With this housing downturn showing no immediate signs of relenting, it remains paramount for Pulte to stick with its near-term operational goals of managing our land development spend, starting only sold homes, aggressively moving spec inventory, and matching our overhead spend to the size of our business.

We are also focused on capturing the demand that does exist today by finding the right combination of pace and price in each of our markets and communities. Let me discuss our progress in these areas.

I stated that our strategies surrounding land inventory centers on significantly reducing spending on land development, reducing the supply of lots under control, and renegotiating existing option agreements to purchase land. At the end of Q3 2007, Pulte controlled approximately 172,000 lots, down 10% sequentially from the second quarter 2007, down 41% from the same period last year, and 53% lower than our third quarter 2005 peak.

Our spending on land will continue to be small and focused on limiting the spending to current projects and take-downs on finished lots, where we still see an acceptable absorption pace in margin. We want to generate cash at the community level in every project where that is practical.

To touch on house inventory for a moment, the number of speculative homes at the end of the third quarter was approximately 4,000 units, down 48% from last year’s third quarter. Our completed spec inventory stood at approximately 1,100 homes, or about 1.6 finished homes per community. This represents a small increase of 300 units versus the second quarter of 2007, but a 34% improvement versus this time a year ago.

Given the high cancellation rate for the quarter, we are relatively pleased with our ability to keep total spec and completed spec units under control. Our field operators are doing a good job managing this area of our business, as they continue to focus on reducing spec inventory to the lowest possible levels in each of our markets.

I’ve stated for a while that we strive to preserve margin and not force volume where we see an absence of demand. With cancellation rates still high and buyer sentiment waning, it is not prudent to begin construction of homes where we are not confident we can sell that home prior to completion.

Part of our short-term strategy continues to be on reducing spec inventory and not forcing volume through continuing price decreases. Settlement revenues for the third quarter 2007 declined 31% from the third quarter 2006 levels, as home closings decreased 28% for the same period. Average sales price was also down approximately 4%.

Third quarter 2007 sign-ups totaled $1.3 billion, as our average sales price per sign-ups were 16% lower from the same period a year ago, and unit volumes decreased approximately 37% year over year.

Net new ordered dollars represent a composite of new order dollars, combined with other movements of the dollars in backlog related to the cancellations and other change orders.

Our cancellation rate was 44% for the third quarter, higher than the 36% rate for the third quarter of 2006 and an increase from the 28% rate we experienced in the second quarter of 2007. Once again, Dell Web outperformed Pulte's other brands, with a 35% cancellation rate for the third quarter 2007.

The increase in the overall cancellation rate reflects both a tightening of mortgage liquidity and the inability of buyers to sell their existing homes in order to close on ours.

Let me provide some commentary on what our regions experienced. After three consecutive quarters of some improvement, our Northeast operations were somewhat softer in the quarter. Sign-ups for the Northeast in the third quarter were down 35% year over year. New communities opened earlier this year in Long Island helped sales there. However, temporary interruptions in mortgage availability for our customers in Washington D.C. and Philadelphia significantly impacted our sales and backlog.

The Southeast, which includes the Carolinas, Georgia, and Tennessee, saw their sign-ups increase 8% compared with last year’s third quarter. An increase in community count helped our South Carolina coastal and Atlanta markets increase their sign-ups year over year by 37% and 15% respectively. We continue to see better performance from our Southeast divisions relative to the rest of the country.

Our sign-ups are down only 6% in our Florida operations versus the third quarter of 2006. However, the environment remains difficult as high levels of both resale inventory and unsold specs continued to negatively impact margins.

Our sales in Fort Myers, Sarasota were down nearly 50% from the third quarter of 2006, as inventories are high in this market and pricing remains soft. Our Southeast Florida, Orlando and Tampa markets showed increased sales of 45%, 22%, and 9% respectively versus the third quarter of 2006. We were very aggressive with our pricing to drive this volume improvement to reduce spec inventory and overall, these are still very difficult markets.

Sign-ups were down 57% in our Midwest operations versus the third quarter of 2006, signaling that the operating environment there continues to be very challenging. Minneapolis and Chicago were our softest markets with a 67% and 62% decrease in sign-ups respectively year over year. Our Chicago operations benefited last year from the opening of our Grand Dominion by Dell Web community in the third quarter of 2006, when it accounted for over 270 sign-ups. That community is still performing well today but not at the pace we saw in 2006. Our other Midwest markets, Michigan, Cleveland, and Indianapolis also showed weakness in sign-ups.

Our Central region, which includes all of our Texas market, saw sign-ups decline 46% year over year, consistent with the weakness we have seen in this area throughout the year. Our Houston and San Antonio markets suffered the largest decline, each slightly over 50% versus the third quarter of 2006. Our strategy to reduce community count in these markets is responsible for some of this decline.

Other factors are the difficulty our customers are having selling their existing homes. This is particularly troublesome for our active adult communities in Dallas and San Antonio, where they attract a more local buyer versus destination buyers.

Our Southwest segment, which includes Colorado, New Mexico, Las Vegas and Arizona, showed a 47% decrease in sign-ups from the third quarter of 2006. This decline was most felt in our Phoenix market, with sign-ups down 73% year over year. High cancellations had a much greater impact on this decline in sign-ups versus the decrease in gross orders, as tighter lending standards and excess inventory really had a significant impact on our operations there. Two of our markets, New Mexico and Las Vegas, suffered much smaller declines in sign-ups of 4% and 17% respectively.

Sign-ups declined 51% year over year in our California operations, as compared with only an 18% declined during the second quarter of 2007. In Northern California, we saw a 54% decline in sign-ups and we were off an additional 47% in Southern California. The amount of excess inventory of new and existing homes continues to plague both of these areas.

Our Central Valley operations in Northern California and the Riverside market in Southern California were particularly hard hit. California is a very difficult housing environment and we will continue to make adjustments to drive the best performance we can in the midst of this downturn.

We know that the deteriorating operating conditions we saw in the third quarter were driven by a number of factors that we’ve already discussed, including the tightening of mortgage liquidity. Unfortunately, until mortgage liquidity returns to the appropriate levels, we can expect high cancellation rates to continue. In the meantime, our operators are finding the right price to move spec inventory, putting the brakes on land spending, and focusing their efforts on being cash flow positive in all their communities. This challenging operating environment may be with us for some time and we are executing on these short-term strategies to position Pulte for long-term success when the dust settles from the current downturn.

I would now like to turn the call back over to Calvin Boyd.

Calvin Boyd

Thank you, Steve. I want to thank everyone for your time and attention on the call this morning. We are now prepared to answer your questions. So that everyone gets a chance, participants will be limited to one question and a follow-up, after which they will have a chance to get back into the queue. At this time, we will open up the call to questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Michael Rehaut with J.P. Morgan. Please proceed.

Michael Rehaut - J.P. Morgan

Thanks. Good morning. First question is on the impairments. I was wondering if you could -- I’m sorry if you did this already, but kind of give a regional breakout of where the impairments were concentrated this quarter. And in terms of the approach, I was wondering -- I think last quarter you might have mentioned that you were still more sticking to a -- in terms of future assumptions, that pricing would be more constant, and I was wondering if with the continued large charges, if you’ve become even more aggressive with your future assumptions in terms of pricing, maybe even going forward would fall another 5% or 10%.

So two parts to that question -- first again the regional concentration and secondly, if you’ve become more aggressive in your future pricing assumptions.

Roger A. Cregg

I think if you look at the webcast, we supplied a slide there that breaks that down. Three of the main areas, certainly Florida, the Southwest and California represent probably about 77% of the total, so you can see those areas and the areas where pricing and mortgage availability played into that.

From a pricing standpoint, we’ve been holding our prices but discounting. Certainly I think if you look at our margin levels that we’ve talked about over the last couple of quarters, for what we’ve been impairing and getting back into our margins, we’re certainly seeing the discounting moving in that direction as well. For instance, our first quarter was about 12.8% in margins and then second quarter, about 13.1%, and then third quarter, about 13.5%, and that was all without impairments -- 13.4% in the third quarter, excuse me.

So what we are ending impairing and getting back, we are also seeing the discounting to go with that as well. So in each one of those markets, it is competitive and we are continuing to drive for cash as well, so we are not going to sit there with product not going anywhere, as we see a lot of that competition.

I think the guidance in the fourth quarter for margins, looking in the 10% to 11% range again is indicative of what we experienced through the last quarter, maybe a little bit more for deliveries. So we have seen deterioration as we’ve talked about and others have talked about coming through 2007 and it’s almost been a month-by-month.

Michael Rehaut - J.P. Morgan

But in terms of the assumptions for the actual impairments themselves, have you become -- given that this is the second quarter in a row of a substantial impairment number, this quarter versus last, have you been assuming -- are you starting to assume a continued decline in pricing and that’s why the impairments continue to be so large, or is it just that in reaction to the continued deterioration in the market?

Roger A. Cregg

I would tell you it’s a significant amount of the reaction, if you look where -- again, where we experience most of it, you look into more than 50% in the Southwest and in California, you’ve got a lot of the Dell Web product there, the length of time for those projects plays a lot on the discounting and the cash flow methodology. So overall, we are working into the impairments based on the current market pricing, so I would say it is indicative of what is going on in the market, not a view that we want to continue to drive the pricing down.

Richard J. Dugas

Just to add to that, we did state pretty clearly that we did lower pricing pretty dramatically during the third quarter and we do feel we’re at the point in some communities where price is not moving product a lot, it’s getting to be a bit inelastic. So we’re have to see what happens in the fourth quarter relative to pricing and what that does to impairments going forward.

Michael Rehaut - J.P. Morgan

Finally, could you just concentrate or apply that statement to Florida? Certainly that’s -- you know, the declines there have moderated a little bit for you and what do you attribute that to? I know you’ve kind of gone through some areas where you’ve gained some traction from a unit standpoint, but is it just that you felt that you’ve lowered price to the extent that you found the buyer, or -- what particular dynamics are do you think driving some lesser declines relative to the rest of the company?

Steven C. Petruska

You hit the nail pretty much on the head. The only places that we were kind of showing some stabilization are Orlando and Tampa and our business in the Southeast was fairly okay. And that is really driven by price. I mean, we have -- it’s a very, very competitive market and our operators are doing a pretty good job of driving price there. I think that they’ve got a good reputation in those markets as well and they’ve consistently been J.D. Power winners and those type of things work to your advantage in this environment.

But it’s not for the market getting any better, that’s for sure.

Operator

And your next question comes from the line of Nishu Sood with Deutsche Bank. Please proceed.

Nishu Sood - Deutsche Bank

Thanks. Good morning. I wanted to follow up on this issue of lowering prices to the level to attract demand, and the related question of whether or not communities should be mothballed.

Just curious; what parts of the country are you seeing the inelasticity of demand where you are not able to lower your prices enough to attract the demand and related, so where are you mothballing communities and approximately how many? Or is it not really an issue of geography, it’s more of within a market, market by market?

Richard J. Dugas

I’ll just begin and then Roger can give you a little bit of detail. I would tell you it’s not really by geography. It’s kind of more of a broad-based situation. I think earlier this year, as you lower pricing you got something for it. Now, it appears you are not driving as much volume, so hence our focus to really concentrate on more promotional activities or other things to try to drive business versus just a pure price play.

Roger, I know you might have some more detail.

Roger A. Cregg

Yeah, just a definition. There’s a lot of definitions of what mothballed is and I would tell you we have very few communities that we are selling in that we just decided we are going to close up the models and leave them vacant and walk away. So that is not our definition of mothballing.

Our definition of mothballing is we’ve got a project that typically we’ve either started to develop or not started to develop, and decided putting money into those developments now where we don’t need the lots, we don’t want to do.

So our view of mothballing is to take properties like that and not put any more money into it until potentially there’s a time and opportunity going forward. Also, that does not mean that we don’t take impairments on those because we have taken impairments on mothball communities as well, so we are not trying to defer any bad news on that aspect.

I would tell you probably roughly about 20-some odd parcels, and they are not particularly concentrated anywhere but around the United States, where we looked at the lots that we have on the ground, the demand that we particularly don’t need to be putting money and the cash into that at this point in time. So that’s relatively how we view projects that are mothballed.

Nishu Sood - Deutsche Bank

So is the issue with these communities, maybe a common thread might be that they are perhaps B-grade locations rather than A-grade locations, for example?

Roger A. Cregg

I would say there are some like that, of course. Again, as we were looking at land that we had taken down in particular markets, or the demand actually fell off, so there are some in the A category as well that we feel pretty good about, but the lots in that market just today, we don’t need to be putting the cash in. So if the demand picks up, we’re looking to get back into the game there. But in the short-run, looking at just putting cash in and watching it sit in the ground as the demand continues to languish in these markets is not prudent management at this point.

Richard J. Dugas

Just to add a bit of color there, really our test on that comes down to cash flow. And as Steve mentioned in his comments, we want to be cash flow positive in as many if not all communities going forward. And versus an A or B location descriptor, there’s so many factors that are hitting the housing market right now, I don’t think it’s fair to say that it’s all B locations. It’s more a question of are you going to be cash flow positive over the next six to 12 months or not, and if you’re not, in a lot of cases we’re choosing to just wait with that investment.

But as Roger indicated, it doesn’t mean we wouldn’t impair it based on what we think, so it is a focus on cash generation, very clearly.

Operator

(Operator Instructions) Your next question comes from the line of Kenneth Zener with Merrill Lynch. Please proceed.

Phil Drummer - Merrill Lynch

Hi, this is Phil [Drummer] calling for Ken. I’m just wondering if we can get your total number of units under production.

Richard J. Dugas

Bear with us as we dig for that, Phil. Something else maybe in the meantime?

Phil Drummer - Merrill Lynch

Well, just kind of related, just wondering if you have a normalized target for total units under production that you are striving for. And then, once you’ve reached that level, what’s that going to mean for future cash flow, whether it’s going to be more difficult to generate future cash once all these finished homes are sold off and ones you can’t really rely on yet, the declining whip anymore.

Richard J. Dugas

First of all, I’ll let Vinnie give you the numbers and then I’ll answer your question on --

Vincent J. Frees

As of 9/30/07, we had just under 13,000 units under construction, and that’s comparative to 9/30/2006 where we had just under 20,000 units under construction.

Richard J. Dugas

And then in answer to your question, there is not a target for units under production that we have. Obviously we are trying to start only sold homes. That doesn’t happen to be the case all the time, and like a 40-unit building in the Northeast where we’ll -- with a 10-month or a nine-month building time where we’ll sell half the units and then start the building and know that we can complete the rest of the units during the -- complete the sale of the rest of the units during the course of construction.

So our target remains really around starting sold homes, so you’ll see our work in process continue to grow if we could increase our sign-up pace a little bit, but from an overall standpoint, we want to focus on taking spec production out and put sole production in.

Roger A. Cregg

And from a cash flow standpoint, we continue to look at the demand and the need for development. Again, all that plays into the cash flow that’s needed in any given month in any given week in any given quarter, as we continue to balance the supply and demand. So all of that is based on what we sell and what goes forward, not just on what’s in production at any point in time.

Operator

And your next question comes from the line of Timothy Jones with Wasserman and Associates. Please proceed.

Timothy Jones - Wasserman and Associates

Good morning. A couple of questions; one, could you give me your number of employees this year versus last year and the peak both in the housing number and the total number?

Vincent J. Frees

Tim, I can probably find our employee count for you. Our employee count this year, at 9/30/07, is 9,400. That’s down about 3,100 employees from 12/31/06. That’s about a 25% decline. Did I hear you ask a question about the peak?

Timothy Jones - Wasserman and Associates

Well, the peak or the other thing, I mean, was that just general employee count include your non-housing operation? Is that just for housing or in total?

Vincent J. Frees

It includes our Pulte business building systems in Arizona and Nevada, and it includes our mortgage operations as well.

Timothy Jones - Wasserman and Associates

What I’m trying to do is compare people with just the housing operation.

Vincent J. Frees

Okay, that looks like, of the 9,400 -- let me think. I’ve got to add a few numbers together -- about just over 8,500 relate to housing.

Richard J. Dugas

Tim, just to clarify, that includes a substantial number at our PVS operation out in Arizona and Nevada, which actually construct homes, so it may not be an apples-to-apples versus the way some other builders have their number.

Timothy Jones - Wasserman and Associates

Okay, the other question is you talked about 150 basis point reversal or something in the upcoming quarter. Is that having to do with a plan that you’ve taken that you have in the reversal -- what was that?

Richard J. Dugas

Yes, that is the margin impact that we are expecting or projecting in the fourth quarter from impairments that we took in the third quarter. So we would see that 150 basis points in the margin percentage prior to or before any adjustments that could be made from valuation adjustments.

Operator

And your next question comes from the line of Stephen Kim with Citigroup. Please proceed.

Stephen Kim - Citigroup

I guess my first question is could we get the specific numbers for homes under construction and land under development [inaudible] future, with any adjustments, you know, breaking out the adjustments from the write-offs this quarter?

Roger A. Cregg

Not on the call, Stephen.

Stephen Kim - Citigroup

Okay, let me get two more questions then, if you don’t mind. My first one relates to the issue that Tim just mentioned. He was talking about the backing out, and I just wanted to make sure that we were very clear. You are saying that 150 basis points of benefit is anticipated in the fourth quarter as a result of prior write-offs. Is that a number that you could share for us as for what happened this quarter? Because I missed it, if you gave it.

Roger A. Cregg

Let me be specific; the 150 is not from prior -- the 150 in the fourth quarter that I’m anticipating is from this quarter, and so each quarter, there are benefits from other quarters in the current quarter. So for the fourth quarter, that was what I was relating to, was the 150 from this quarter.

In the third quarter, from the impairments we took in the second quarter -- excuse me, probably the first, second and third quarters, or first and second quarters in the third quarter, was about 105 basis points. And then if you looked at this year and took last year as well, there was probably about 46 basis points. So our impairments in the third quarter would have contributed roughly about 150 basis points in the third quarter.

Stephen Kim - Citigroup

Okay, that’s really helpful.

Richard J. Dugas

Which I think you indicated was about $36 million?

Roger A. Cregg

About $36 million, yes.

Stephen Kim - Citigroup

Okay, that’s really helpful. The second question I have related to this insurance charge. It’s been what, $30 million in the second quarter, I think another $20 million you said this quarter. I just wanted to make sure I understood exactly what that was related to and are you suggesting in your guidance that that’s pretty much going to go away after the third quarter?

Roger A. Cregg

Yes, we believe so. We believe based on severity and frequency of construction claims, and we do this actuarially, so we work with actuaries putting together these claims and they project out. So I think I mentioned even last quarter, if you have something like a hundred-year flood, and then you have two of them, actuarially, you have to make an assumption that you may have more than one.

So actuarially, we look at our reserves and we calculate based on our experience and frequency and severity of the claims going forward what they may be. So far this year, we’ve taken roughly about $50 million in adjustments to that reserve. And again, as things come up, we continue to look at it and scrutinize it, we feel pretty good about the level of the reserve at this point.

Operator

And your next question comes from the line of Alex Barron with Agency Trading Group. Please proceed. Mr. Barron, your line is open, sir.

Alex Barron - Agency Trading Group

Can you talk about how you are going to get to the $1 billion in a little bit more detail, please?

Richard J. Dugas

I can give you an overview and then maybe Roger can chime in with some specifics, Alex. It’s really a combination of closings, bringing cash in along with a substantial reduction in overall spending going forward, particularly on the land development side.

As Roger mentioned, we are looking at every single community, looking at making sure that it is going to be as close to cash flow positive, if not cash flow positive, as we can. So it’s a combination of volume coming in and reduced spending. We’ve been projecting that target for some time.

Roger, you might want to --

Roger A. Cregg

That’s exactly what it is. It’s a change in working capital from sales and relief of land, so that’s what’s going to generate the cash.

Alex Barron - Agency Trading Group

Can you also talk about this monster sale you guys are running? Is that nationwide and what’s the average price cut you are offering?

Steven C. Petruska

I can speak to that. We had an event, it was last weekend, and it was nationwide and it -- you know, in most cases what our operators were doing with their pricing was repackaging what we had out there already anyway.

I would tell you that on homes that could close within a 30 to 60 day time period, they were a bit more aggressive and we might have seen an incremental 5% to 7%, but we were already fairly aggressive with our pricing at that point and what we wanted to do was create a certain amount of energy in a national event around that, and obviously leverage our spend from an advertising standpoint.

Operator

And your next question comes from the line of David Goldberg with UBS. Please proceed.

David Goldberg - UBS

Thanks. Good morning, guys. My first question is about the TCG and as you know -- the TCG way to estimate demand and try to figure out what demand is going to be and how that changes in the current market environment. Are you guys making changes to what each of the target groups would want?

Richard J. Dugas

Actually, we continue to refine each of the 11 consumer groups that we target in terms of their offering. That’s kind of a continuous basis and we still have a strong effort underway there.

In this environment, in terms of what they want, generally speaking the choices that people are interested in overall don’t change. It’s a question of whether they can afford them, given the mortgage situation and the amount of inventory out there. So I would tell you no, we’re not radically changing a lot. We are continuing to focus on including as many things standard into the home that people want going forward.

Steve, you might speak to that a little bit more.

Steven C. Petruska

Just on an overall basis, what we -- we’re afforded the opportunity today with obviously some of the impairments on our land is to say now can we hit a price point where we can attract additional TCGs and does that warrant a different go-to-market strategy that might increase the absorptions in the community? We’re seeing opportunities to do that and in many cases, we will redeploy a different model park scheme. We may be able to afford to put a larger home on a similar lot now and still offer it at a price that is extremely competitive in the marketplace.

So we’re looking at all that. Our focus on the consumer obviously gets sharper during times like this and we are seeing that as a continued opportunity.

David Goldberg - UBS

I guess my follow-up question is for Roger; if you could get into helping us quantify on these mothball communities, how you run impairment charges? What kind of assumptions you make? If there’s no big price, how can you figure out what your potential impairments are going to be?

Roger A. Cregg

I think what you look at is that if you assume that you were going to sell product on there for $300,000 for a price out of a home, but that house is selling at $200,000 today, you wouldn’t necessarily mothball it at the $300,000 level. So it gives us an idea of what the homes are selling for in that market, because we clearly had intentions of selling specific homes targeted at specific TCGs in that particular community. So our effort there is to take a look at what the market is doing for that particular product, relative to the market itself, and then we take a look at the overall cash flows of that, based on current market pricing versus what we anticipated and really, how we underwrote it.

Operator

And your next question comes from the line of Susan Berliner with Bear Stearns.

Susan Berliner - Bear Stearns

Good morning. Just a couple of questions; I apologize if I missed this -- did you give the average incentive rate for this quarter?

Roger A. Cregg

The average incentive for home discounts and that type of thing?

Susan Berliner - Bear Stearns

Exactly.

Roger A. Cregg

No, we didn’t. Roughly the -- I’ll categorize this in a couple of different categories, because discounting has been running anywhere between 6% and 12%. On average, we’ve been running around 9% for the quarter. Commissions and closing at discount points probably represent almost another 6%, so roughly it’s been running in the 14% to 15% range for this quarter.

If you went back almost a year ago, it was roughly around 11% with all those combinations, so I think what we’ve seen is deterioration coming through and certainly that’s based on closings. That’s not based on what actually we’re seeing today in the market. We’ve talked a little bit about the deterioration and that was the overall view of the fourth quarter and the margin deterioration [has moved that closer] to the P&L as we close the homes.

Susan Berliner - Bear Stearns

That’s great. My second question is can you guys give any color as to any impact or what you are seeing with the fires in California and how your insurance would protect you?

Richard J. Dugas

Right now, we don’t have any exposure. We don’t have communities in those specific areas right now, so we are in pretty good shape from that point. Typically, it would be homes that we had constructed that we hadn’t closed yet that we’d be liable for at that point, from an insurance standpoint for coverage. But again, we don’t have any exposure there.

Operator

And your next question comes from the line of Dan Oppenheim with Banc of America Securities. Please proceed, sir.

Dan Oppenheim - Banc of America Securities

Thanks very much. I was wondering if you could talk a little bit more about your expectations for the fourth quarter and you were talking about doing more in terms of building homes only when they are pre-sold. Is your expectation that the cancellation rate comes down from 44% currently going to the fourth quarter guidance? I guess I want to get more color in terms of how that cancellation rate trended during the quarter and if it was still rising. So just how you are thinking about dealing with that and pricing.

Steven C. Petruska

I would tell you that overall, yeah, we’re expecting cancellation rates to stay high. I would expect that given mortgage liquidity and still house sell difficulty, we’re going to continue to see, whether it would be high 30s to low 40s on a cancellation rate standpoint. So that’s all factored into the guidance that Roger gave and it is certainly factored into the way we are looking at the first quarter.

Unfortunately, we still continue to get a pre-sell, we’ll start the home but given that cancellation rate, we’re end up getting back at some point during the construction process and we attempt to move that house very quickly.

That’s why on an overall standpoint, we’re saying we are only starting sold homes, but as you know, that home business base sold throughout the course of production.

Dan Oppenheim - Banc of America Securities

Thanks very much.

Operator

And your next question comes from the line of Carl Reichardt with Wachovia Securities. Please proceed.

Carl E. Reichardt, Jr. - Wachovia Securities

I wanted to ask a little bit about stores. If you guys end up hitting what your expectations are from an absorption and sales price perspective that’s embedded in your impairments going forward, what is your sense as to what will happen to your store count in ’08 versus where you will end up in ’07?

Richard J. Dugas

They are going to come down but we are not providing a lot of detail on that right now, Carl. Go ahead, Roger.

Roger A. Cregg

That’s right. We’re not giving any guidance on it but certainly with the effort on pulling back because the market is pulling back, the community count we’ll be pulling back as well.

Carl E. Reichardt, Jr. - Wachovia Securities

Okay, and then you mentioned, or I think Steve was talking a little bit about potential mix shifts within communities that might be selling at a slower pace than you’d like. How do you look at Web communities in particular, where you’ve got a lot of lots out in front of you and you may need to shift the mix of product? How do you increase demand without price adjustments in a Web community? What tactics do you use?

Steven C. Petruska

That’s a real difficult one. Mostly, the tactic that we use is lot size tactic, and we will look at what product is actually moving. It is typically not an introduction of new product, because our Dell Web product line across the country is fairly tight, in that we probably don’t offer an array of any more than 15 to 20 floor plans nationwide on that.

But you know, it’s real difficult because we are way more sensitive in a Web community about any price decrease, so we can tackle it pretty aggressively with pricing as it relates to premium values and those types of things, but on base pricing, we don’t have much room to move and we’ll adjust mix where we can, but even in that case most of those projects, even though they have a large lot count, Carl, are fairly fixed on an overall density, so we can’t mess with it too much.

Operator

And your next question comes from the line of James Wilson with JMP Securities. Please proceed.

James Wilson - JMP Securities

I was wondering, just continue on Dell Web, could you contrast a little bit what you are seeing in the way -- I know you say it’s hard to pull down pricing, but what you are seeing in sales pace or how the margins look in -- I guess maybe in particular in some of your largest Dell Web communities around the country compared to the corporate averages?

Steven C. Petruska

On an overall basis, I would tell you that we’ve got a hit or miss opportunity with our web communities as well. They’re performing very well in the Carolinas, with pretty healthy margins still. Not necessarily at the pace they were 18 months ago, but it’s still acceptable absorption paces, whereas in Arizona, they are still soft and whether that buyer is local and we see a lot more impact where it’s local, as I talked about in my prepared comments in Texas, or whether that buyer is relocating, in many cases they still have a home to sell to be able to put their money in to the Dell Web home. So it’s still impairing our ability but as you can see by our lower cancellation rate, that typically when we get these buyers under contract, we can maintain them in our backlog for a little bit longer and typically bring them to closing. But it is a struggle, it’s just not quite the struggle that we see on the Pulte side of the business.

Richard J. Dugas

I think it’s just a slightly different environment there. The buyer still wants to buy a Web home -- it’s just a question of house to sell. It’s not that it’s not impacted, but as Steve indicated, impacted just less.

James Wilson - JMP Securities

And again, are the margins -- is the profitability running better at Dell Web than it is for the rest of Pulte, so that actually Web otherwise brings margin best?

Richard J. Dugas

I would say mostly representative across the country, the Dell Web product has got better margin points than the traditional side.

Operator

And your next question comes from the line of [Dennis McGill] with [Gillman & Associates]. Please proceed.

Dennis McGill - Gillman & Associates

The first question just has to do with the development spending that you had talked about. In certain communities you are pulling back there, focusing on the cash flow. Can you just talk about in ’07, what you expect to spend on development in total, how that compares to last year, and then how much flexibility you have with that number moving forward? And then I have a follow-up.

Roger A. Cregg

I don’t have the specific numbers on how much we spend for the whole year. You know, our focus is definitely to slow down the spending from -- typically, looking at a growth environment, so the development dollars we continue to look at. We have a great deal of flexibility in that and when we put money in the ground, how many lots we developed in a community, when we put amenity centers and that type of thing, so we’ve got a lot of flexibility to look at that cash spending.

Typically we try to run very efficiently in a lot of our operations, putting down hundreds of lots at a time to be efficient with the overall process, and some of that we would give up efficiency to make sure that we are not sitting here with lots in front of us that may last three years instead of typically maybe six months or one year.

So it’s a community-by-community, market-by-market approach and we think we’ve got a pretty good focus on it and our operators in the field are doing an outstanding job of managing all that on a day-to-day basis.

Richard J. Dugas

Dennis, before you ask a follow-up, just to put a point on that, the environment clearly is still difficult in housing and one of the reasons we are able to still keep the $1 billion target relative to our cash on hand at the end of the year is because of the great degree of ability we have to move that number, and our operators, as Roger indicated, are looking at it literally community by community and each section of each community to make sure we are focusing in on cash.

Dennis McGill - Gillman & Associates

Do you have a relative sense of how much that spending would be down versus last year?

Roger A. Cregg

Not versus last year. Again, I think at the beginning of the year, we talked about almost somewhat being neutral and then with the downturn, we started to pull back on it, which again would generate cash for us. But I don’t have that number comparative to last year.

Richard J. Dugas

Dennis, perhaps we can look into that in more detail off the call.

Operator

And your next question comes from the line of James Mccanless with FTN Midwest Securities. Please proceed.

James Mccanless - FTN Midwest Securities

I’ve got a couple of questions for you; first question, in Florida, what is the status of the insurance down there for homeowners? Is it getting any better, any worse?

Roger A. Cregg

Anecdotally, because we haven’t talked to our operator specifically about that, I have not heard that it is getting worse. I would not suspect that it is getting any better, so I think that it stabilized somewhat from -- after the number of hurricanes that they had over the last couple of years.

James Mccanless - FTN Midwest Securities

My other question is on land pricing. With the bankruptcy of Newman earlier this week and some others that we’ve heard about, could you tell us if that’s having any effect on raw land pricing? And then just give us a quick overview what prices have been doing lately?

Roger A. Cregg

Overall, pricing has been coming down for sure, mostly, as we’ve talked about on previous calls, focused around the terms that you can get the land on, as opposed to necessarily the base price. But we have seen some better opportunities to go out and buy land. Quite frankly, we still don’t think it’s a good enough price.

I think that things like the Newman bankruptcy that you talked about take time to process its way through before the land actually reaches market. And we still think that there is still a lot of downside left to come in some of these marketplaces, so in addition to not wanting to put cash into the marketplace, it wouldn’t be a good time even if you want to, in my opinion.

Operator

And your next question comes from the line of Stuart Hosansky with Vanguard. Please proceed.

Stuart Hosansky - Vanguard

I’ve got a couple of questions and you might have answered this in different ways, but first, can you provide a little more information on your geographic pricing trends? You talked about in general that the pricing is lower, but can you be a little more granular on that?

Richard J. Dugas

Generally speaking, price has been difficult across the country. I guess the one area I would highlight that it has not been is the Carolina, mid-Atlantic area. More specifically, as Steve indicated, we continue to enjoy better results in that part of the country than elsewhere. But Steve, beyond that, anything stand out?

Steven C. Petruska

I think California obviously has been the hardest hit. We’ve seen that both Arizona and Nevada probably had some of the most aggressive price increases on land throughout the upturn, so they are seeing some very significant price decreases.

We are at or near the bottom in the Midwest. Texas, we didn’t have a high average sales price to start with there, so as a percentage, it may be down fairly good but from a dollar standpoint, it’s not down much.

But California and the Southwest, and in Florida, they are probably the most significant price decreases that we’ve seen over the last 12 to 18 months.

Stuart Hosansky - Vanguard

Do you think we are anywhere near the bottom in those areas?

Richard J. Dugas

I wish we could tell you. I did mention in my prepared remarks and then on a question earlier that price does not appear to be the driver that it was. I don’t know is the answer to the question. I wish we could give anybody a projection on that. We’ll have to wait and see -- don’t know.

Operator

I would now like to turn the call back over to Mr. Boyd for closing remarks.

Calvin Boyd

Thank you, Carol. Thanks, everyone, for your participation on the call today. If you have any follow-up questions, please feel free to give me a call. Have a great day.

Operator

Thank you for your participation in today’s conference. You may now disconnect and have a wonderful day.

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Source: Pulte Homes Q3 2007 Earnings Call Transcript
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