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Edited Transcript of PHM earnings conference call or presentation 23-Apr-19 12:30pm GMT

Q1 2019 PulteGroup Inc Earnings Call

BLOOMFIELD HILLS May 3, 2019 (Thomson StreetEvents) -- Edited Transcript of PulteGroup Inc earnings conference call or presentation Tuesday, April 23, 2019 at 12:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* James P. Zeumer

PulteGroup, Inc. - VP of IR & Corporate Communications

* Robert T. O’Shaughnessy

PulteGroup, Inc. - Executive VP & CFO

* Ryan R. Marshall

PulteGroup, Inc. - President, CEO & Director

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Conference Call Participants

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* Alan S. Ratner

Zelman & Associates LLC - MD

* Carl Edwin Reichardt

BTIG, LLC, Research Division - MD

* John Gregory Micenko

Susquehanna Financial Group, LLLP, Research Division - Deputy Director of Research

* John Lovallo

BofA Merrill Lynch, Research Division - VP

* Kenneth Robinson Zener

KeyBanc Capital Markets Inc., Research Division - Director and Equity Research Analyst

* Matthew Adrien Bouley

Barclays Bank PLC, Research Division - VP

* Michael Glaser Dahl

RBC Capital Markets, LLC, Research Division - Analyst

* Michael Jason Rehaut

JP Morgan Chase & Co, Research Division - Senior Analyst

* Nishu Sood

Deutsche Bank AG, Research Division - Director

* Paul Allen Przybylski

Wells Fargo Securities, LLC, Research Division - Associate Analyst

* Stephen Kim

Evercore ISI Institutional Equities, Research Division - Senior MD & Head of Housing Research Team

* Susan Marie Maklari

Crédit Suisse AG, Research Division - Research Analyst

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Presentation

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Operator [1]

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Good morning, my name is Jack, and I will be your conference operator today.

At this time, I'd like to welcome everyone to the Q1 2019 PulteGroup, Inc. Earnings Conference Call. (Operator Instructions)

Thank you. Jim Zeumer, you may begin your conference.

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James P. Zeumer, PulteGroup, Inc. - VP of IR & Corporate Communications [2]

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Great. Thank you, Jack. We appreciate everyone joining this morning's call to discuss PulteGroup's first quarter financial results for the period ended March 31, 2019.

Joining me for the call today are Ryan Marshall, President and CEO; Bob O’Shaughnessy, Executive Vice President and CFO; and Jim Ossowski, Senior Vice President, Finance.

A copy of this morning's earnings release and the presentation slides that accompany today's call have been posted to our corporate website at pultegroup.com. We'll also post an audio replay of today's call a little later on today.

Before we begin the discussion, I want to alert all participants that today's presentation includes forward-looking statements about PulteGroup's future performance. Actual results could differ materially from those suggested by 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 Ryan Marshall. Ryan?

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Ryan R. Marshall, PulteGroup, Inc. - President, CEO & Director [3]

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Thanks, Jim, and good morning. It has been discussed extensively that market conditions in the back half of '18 and particularly in the fourth quarter were challenging across the housing industry. We believe that affordability issues driven in part by sustained housing price increases over the last few years along with increasing mortgage rates last year caused homebuyers to become more cautious as 2018 progressed.

The consensus was that buyer interest as measured by traffic to communities remained high, but the conversion of that traffic to signed purchase contracts slowed. Given these conditions exiting 2018, there's been a lot of interest in how homebuyers have been behaving in this spring selling season of 2019.

Before parsing a variety of data points at a high level, here's what I'd tell you about the start of 2019, inclusive of the first few weeks in April.

We are experiencing a very typical seasonal upswing and are generally encouraged by the level of buyer activity that we're seeing. Further, with the strong economic backdrop and the recent decline in mortgage rates, there is every reason to believe that 2019 can be another good year for the housing industry.

Overall, our first quarter results are consistent with an improving demand environment. Reflective of the typical spring selling season, traffic increased on a sequential basis throughout the quarter, with more consumers visiting our communities each month as the quarter progressed.

More importantly, traffic into our communities was also up each month over the same month last year, both in absolute numbers and on a per community basis when adjusted for a higher community count.

Absorption paces also improved during the quarter, although they remain below last year's level.

With that said, it is worth noting that we experienced a very strong start to 2018, so the year-over-year comps are more challenging for the first half of this year. As a result, we are optimistic that the improving demand trends we experienced in the first quarter can continue, and look forward to momentum building across -- building as 2019 progresses.

The past 15 months serve as a clear reminder that we operate in an industry that is cyclical, seasonal, and at times volatile. At the start of 2018, industry forecasts were calling for another year of double-digit growth. By the end of the year, some were calling it the end of this housing cycle and predicting 2019 could see total industry volumes fall.

Now, one quarter into 2019 and roughly 70 basis points lower on mortgage rates over the past 5 months, expectations are changing yet again with some calling for a reacceleration of housing demand.

Given the changeable market dynamics within our organization, we have stressed the need to remain disciplined in how we run our business, stay focused on our key drivers and performance metrics, take a balanced approach to the markets and buyers we serve and continue allocating capital in alignment with our stated priorities.

Central to being disciplined, focused and balanced is making sure that we are offering product that is meeting the needs of consumers we are seeking to serve.

Consistent with this view, I have talked about wanting our operations to be indexed to the local market opportunity and generally more balanced across buyer groups.

In the first quarter, our orders were 30% first-time buyers, 46% move-up buyers and 24% active adults. Adjusting the future mix of buyers requires that we first assemble the needed lots, which is exactly what we're doing. At the end of Q1, our lot pipeline consisted of 35% targeted for first-time, 30% for move-up and 35% for active adult communities.

Our closing mix won't match these percentages exactly, but it does show how our business should evolve to be more balanced over the next couple of years.

Certainly, our transition to a larger percentage of lower-priced first-time buyer lots and the recent decline in mortgage rates can help solve some of the affordability challenges that today's homebuyers are facing.

However, our real opportunity lies in lowering house costs, not just for first-time buyers, but across our entire planned portfolio. To that end, we are utilizing our common plan, value engineering and should costing processes to help identify areas and opportunities to lower our build costs.

We are also advancing initiatives that are looking at everything from basic floor plan designs and associated on-site and off-site build processes to option offerings and go-to-market strategies.

I think we've done well with these activities in the past, but remain focused on finding ways to improve in all of these areas in the future.

Relative to our plans and expectations for the year, Q1 results have us off to a good start, and I like our overall competitive position. We have an appropriate inventory of homes and building lots to meet demand, but we're not inventory-heavy and feeling pressured to move units. As Bob will detail, we continue to realize superior gross margins as we manage each community to deliver high returns.

Before turning the call over to Bob, I want to draw everyone's attention to a press release issued several weeks ago announcing that we promoted John Chadwick to be PulteGroup's new Chief Operating Officer. John replaces Harmon Smith, who had announced his plans to retire after an exceptional 29-year career with the company. John has also had an amazing career with PulteGroup, having spent the past 28 years serving in key roles within our organization. John has proven himself to be an outstanding leader and a highly skilled homebuilding operator. He has led some of our largest and most complex operations, including his most recent role as Area President for our West operations which accounted for almost 40% of our pretax income in 2018.

As you would expect from someone who has spent 3 decades inside our culture, John has a deep commitment to our construction quality and to delivering an outstanding homebuying experience to our customers.

I want to welcome John to the corporate office and thank Harmon Smith for his years of service and passionate commitment to our company's success.

Now let me turn the call over to Bob for a detailed review of the quarter. Bob?

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Robert T. O’Shaughnessy, PulteGroup, Inc. - Executive VP & CFO [4]

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Thanks, Ryan, and good morning. PulteGroup's first quarter results were generally in line with or even slightly better than our guidance for the period, as the company's operations continue to successfully execute their business plans.

I would like to note that as part of my comments, I will be providing guidance on our expected Q2 performance. We want to see how the spring selling season progresses from here and we'll be prepared to provide full year guidance on our next earnings call.

Let me now begin my detailed review of our first quarter results. Net new orders for the first quarter totaled 6,463 homes, valued at $2.7 billion, which are down 6% and 5%, respectively, compared with the first quarter of last year.

As Ryan noted, buyer traffic was high in the quarter, but conversion rates remained slow. As a result, orders in the first quarter were lower across each of our buyer groups. For the quarter, first-time orders were down 1%, to 1,956 homes, move-up was down 11% to 2,946 homes and active adult was down 2% to 1,561 homes.

Adjusting these figures to the 2% increase in our year-over-year community count result resulted in 8% decline in absorption pace for the quarter. Absorption pace by buyer group was as follows: first-time was down 10%; move-up was down 8%; and active adult was down 7%.

Moving to our income statement, home sale revenues increased by 2%, to $1.9 billion. Q1 closings of 4,635 homes is up slightly over last year and ahead of our prior guidance as our operations successfully managed their build cycles. Revenue growth in the quarter was driven primarily by a 2% or $8,000 increase in average sales price to $421,000.

The increase in our average sales price was driven by higher prices among first-time buyers, up 10% to $351,000, and active adults, up 2% to $391,000.

Move-up pricing for the quarter was down approximately 1% to $476,000. For the first quarter, our closings by buyer group included 25% from first-time buyers, 47% from move-up buyers and 28% from active-adult buyers. Last year, our first quarter closings included 28% first-time, 48% move-up and 24% active adult.

At the end of Q1, we had approximately 10,300 homes under construction, of which just under 31% were spec. This compares to more than 34% of our homes under construction being spec in the fourth quarter of last year.

Consistent with comments given on our fourth quarter call, we are tapering spec starts after having made the strategic decision to start more spec homes for production reasons in Q4 of last year.

Given the volume of homes currently under production, we expect deliveries in the second quarter to be in the range of 5,400 homes to 5,700 homes. At the end of the quarter, the average sales price of our homes in backlog was $438,000. Given our backlog pricing, we expect our average sales price for homes we will deliver in the second quarter to be in the range of $430,000 to $435,000. This compares with an average sales price of $427,000 in the second quarter of last year.

Our first quarter gross margin was 23.4%, compared with 23.6% in the first quarter of last year. As discussed on our fourth quarter earnings call, higher capitalized interest expense in 2019 impacted our gross margins by approximately 20 basis points.

Our gross margin came in above prior guidance as the quarter benefited from a better geographic mix of homes closed as well as the continued execution of our strategic pricing programs. The success of our efforts can be seen in our unit pricing dynamics.

For the first quarter, option revenues and lot premiums increased just over 4% compared with our first quarter last year, to approximately $81,000 per closing. This increase was able to offset much of the increase in sales discounts for the quarter, which totaled $17,600 or 4% of sales price. On a year-over-year basis, sales discounts were up 80 basis points.

While buyer interest remains high, the overall pricing environment is more challenging than this time last year. We work to maximize returns at each community, which means we're prepared to adjust price lower or higher as appropriate.

Given current market dynamics, we expect gross margin in the second quarter to be in the range of 22.8% to 23.3%.

Working down the income statement, SG&A spend in the quarter was $253 million, or 13% of home sale revenues, which is slightly better than our guidance due in large part to the increase in our closings compared to our guidance.

Relative to last year, our overhead leverage declined by approximately 40 basis points as slightly higher commissions, insurance based costs and compensation impacted the quarter.

We continue to keep a close eye on expenditures and look for opportunities to reduce overhead costs. With expectations for Q2 closing to be below last year, we will again lose some overhead leverage, as we currently project that our SG&A will be between 11% and 11.5% of home sale revenues.

In the first quarter, our financial services business generated pretax income of $12 million, compared with $14 million in the prior year. While capture rate in the quarter increased 2 percentage points to 80%, profitability was negatively impacted by the competitive pricing environment that continues to exist in the mortgage space. As a result, our pretax income for the quarter was $217 million, which compares to $224 million last year.

Looking at our taxes, our reported income tax expense for the first quarter was $50 million. This represented an effective tax rate of 23%, which compares with 23.8% last year. Our Q1 tax rate was below our guidance as we recorded benefits related to equity compensation and the favorable resolution of certain state income tax matters. Consistent with our first quarter guide, we expect our tax rate to be approximately 25.3% in Q2.

Finally, our net income for the first quarter was $167 million, which compares with $171 million last year. At $0.59 per share, our earnings were consistent with last year.

Our diluted earnings per share in the first quarter of this year was calculated using approximately 279 million shares, which is a decrease of more than 9 million shares or just over 3% from last year. The lower share count is due primarily to share repurchase activities executed over the past 12 months.

During the first quarter of this year, we repurchased approximately 900,000 shares for $25 million or an average price of $27.16 per share.

At the end of the first quarter, we had $1.1 billion of cash and a debt-to-capital ratio of 38%, which is down from 42% last year. Adjusting for cash on the balance sheet, our net-debt-to-capital ratio was 28%.

Let me close out my comments with a few operating metrics.

For the quarter, we operated from 858 communities, which is up 2% from last year. Our community count for -- guide for the year and the quarters continues to be that we will be roughly flat on a year-over-year basis in each quarter. Any variation from that, as we experienced in the first quarter, will likely reflect the slower close out of existing communities rather than an acceleration in new community openings.

Land acquisition spend for the quarter totaled $305 million, which is up about $15 million from last year. In the quarter, we put just over 4,000 lots under control, of which 54% had some form of option component. We continue to focus on smaller, faster-turning communities as the average project size was 120 lots.

Having said that, we expect to complete a larger-scale deal with American West in the Las Vegas market. Under the terms of this transaction, we will put approximately 3,600 lots under control, of which approximately 1,200 finished lots will be acquired in 11 communities, with the remaining 2,400 lots being controlled via option.

While we are not providing the terms of the transaction, I would note that we project that the owned lots represent less than 2 years of supply based on current paces and that we expect to realize our first closings from these communities in the first quarter of 2020.

Together with our existing business and related investments we've been making in the market, this transaction will enable us to dramatically increase our local market share in Las Vegas beginning in 2020.

At the end of the first quarter, we had approximately 149,000 lots under control, of which 90,600 or 61% were owned, with an additional 58,000 or 39% held via option. Based on our trailing 12 months of closings, we own roughly 3.9 years of land.

Now let me turn the call back to Ryan for some final comments on market conditions. Ryan?

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Ryan R. Marshall, PulteGroup, Inc. - President, CEO & Director [5]

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Thanks, Bob. At the risk of repeating comments that I made at the outset of our prepared remarks, I will provide some regional color before we open the call to Q&A.

Across the eastern third of the country, demand conditions were generally challenging in the quarter for a number of our markets. On a relative basis, Florida continues to be among the stronger areas of the country.

In the middle third of the country, demand conditions actually held up pretty well, with Texas showing the best year-over-year growth of our reporting areas.

And in our western operations, we continue to see meaningful variation in market performance, with the ongoing strength in Arizona helping to offset slower demand in California.

Again, at a high level, I would say that the overall operating environment feels much better than what we experienced in the back half of 2018.

We are optimistic that 2019 can turn out to be a good year for the housing industry, with demand supported by strong jobs and historic lows in unemployment, which is allowing for some wage inflation and continued high consumer confidence. With mortgage rates expected to stay low, the overall operating environment remains favorable.

Let me close by saying thank you to our employees and our trade partners who continue to do an outstanding job building great homes and delivering a superior experience to our customers. Jim?

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James P. Zeumer, PulteGroup, Inc. - VP of IR & Corporate Communications [6]

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Great, thank you, Ryan. I apologize for any background noise you may be picking up, as they decided today would be a good day to do some work on the adjacent elevators. I apologize for that. With that said, we will open the call for questions. So that we can speak with as many participants as possible during the remaining time of the call, we ask that you limit yourselves to one question and one follow-up.

Jack, if you'll explain the process, we'll get started.

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Questions and Answers

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Operator [1]

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Certainly. (Operator Instructions) Your first question comes from the line of Mike Dahl with RBC Capital Markets.

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Michael Glaser Dahl, RBC Capital Markets, LLC, Research Division - Analyst [2]

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Ryan, I wanted to follow up just with a question about the improvement that you're talking about. And just curious, given the comments around absorption remaining lower but improving through the quarter, can you give us any sense of quantification from a monthly standpoint? And any color on April so far?

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Ryan R. Marshall, PulteGroup, Inc. - President, CEO & Director [3]

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Yes, Mike, really not a whole bunch more that I can add other than what I think what I shared with you in our prepared remarks. But we're seeing the typical spring selling season where things have continued to get better as we moved from January to February, February into March. Traffic has been strong, both year-over-year but also on a sequential basis, so we're very pleased with that. I think some of the stability that we've seen -- and really the decline in mortgage rates, I highlighted in my prepared remarks that it's been 70 basis points over the last 5 or so months. I think all those things are helping to create an environment where we're optimistic about what we see for 2019. As I mentioned, we had a tough comp relative to the first quarter of 2018, it was really a spectacular time for the company and the industry. So as we look at how we are positioned, we like where our communities are at, we like the investments that we have made. I think our team is operating very well. We're competing favorably in the eyes of the consumer. So that's part of the reason that we're optimistic about what we have in the coming year.

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Michael Glaser Dahl, RBC Capital Markets, LLC, Research Division - Analyst [4]

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Okay, encouraging to hear. And then my second question relates to gross margins; clearly some real strength there even with respect to your prior guidance. Could you give us a sense of -- I know from a regional standpoint, the West was stronger on deliveries, and that typically carries a higher margin. Can you give us a sense of kind of what was mix-related versus what was kind of core strength and less discounting than you previously assumed, in terms of breaking down that bridge versus the guide?

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Robert T. O’Shaughnessy, PulteGroup, Inc. - Executive VP & CFO [5]

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Yes, Mike, it's Bob. And as always with margin mix matters -- and you've highlighted it -- we tried to touch on it in the prepared remarks. Certainly, we were able to close more homes in California than we were expecting in the first quarter, which benefited the margin relative to our guide. Also, if you look at the mix of business, it was a little bit richer with Del Webb than it had been in the prior year, which also benefits the margin on a relative basis. You know, the other thing I think that happened is we came into the year a little bit heavier on spec -- we talked about that in the fourth quarter -- and we've sold some of those houses. You can see we're down to 31%. And we did a little bit better on those houses than we were forecasting. So we didn't discount quite as much. We highlighted that the discount rate was up about 80 basis points, which is just under $4,000, but at the same time, our lot premium and option revenue was up almost an equivalent amount. And so, you know, I would tell you, we did a little bit better on the spec sales than we thought, which also benefited our margin relative to the guide at the beginning of the quarter.

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Operator [6]

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Your next question comes from the line of Stephen Kim with Evercore ISI.

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Stephen Kim, Evercore ISI Institutional Equities, Research Division - Senior MD & Head of Housing Research Team [7]

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So just taking on that comment about how you did better on your temporary spec program than you maybe expected. That is something that we were kind of looking for, and I was curious as to whether or not there's any lessons learned from that. And if you were to experience another period in the future of rate volatility, let's say, would you be inclined to pursue a more aggressive spec posture than you historically or normally would in light of the success you've had in the past -- in this most recent quarter?

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Robert T. O’Shaughnessy, PulteGroup, Inc. - Executive VP & CFO [8]

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Yes, Stephen, I think it's important to remember, we didn't say that the margins were higher on those spec sales, just higher than we expected coming into the quarter. And so we continue to believe that there is value in having some inventory on the ground. We've got less than one finished spec though, and we've highlighted that over time. So we don't want a bunch of standing inventory around. So I think at the end of it, we were opportunistic because we wanted to keep the production line running at the back half of the year relative to the sales environment then. But I think you can and should expect to see us drive that spec percentage back down into that high 20s or leave it where it is today; it will depend on the sales environment over the next 4 to 8 weeks. But again, I think the -- we focus on return, and getting those homes sold before they finish is important to us.

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Stephen Kim, Evercore ISI Institutional Equities, Research Division - Senior MD & Head of Housing Research Team [9]

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Got it. And then secondly, I was curious if you could talk a little bit about the absorptions. Obviously, all communities are not created equal. And just based -- when you look at the mix of communities that you're likely to have in 2Q, would it be reasonable for us to expect that absorptions on a year-over-year basis -- and the comp also gets a little bit easier -- might be able to be flat to up on a year-over-year basis. Is that kind of what you're expecting with the absorptions? Or are you anticipating that absorptions will continue to be negative trending until you get to the back half of the year?

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Robert T. O’Shaughnessy, PulteGroup, Inc. - Executive VP & CFO [10]

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Yes, it's a challenge for us to guide to absorptions, we haven't done it, Stephen, candidly. And so I think we'll see how the selling environment goes. We saw a tapering in sales after April of last year. And so if sales remain strong on a relative basis, you could see it flat. Again, it's going to depend on how the sales season goes.

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Operator [11]

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Your next question comes from the line of Alan Ratner with Zelman & Associates.

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Alan S. Ratner, Zelman & Associates LLC - MD [12]

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So on the gross margin, very strong result this quarter. The guidance seems like you're expecting maybe a little bit of sequential pressure in 2Q, but obviously, still well above what you thought you were going to hit this quarter.

Just kind of moving the moving pieces around here on the mix and cost and price, can you just talk a little bit about what goes into your 2Q guide? Is that any unwind from the mix benefit that you saw this quarter? Or is this kind of where you see the price versus cost dynamic currently, meaning costs are still going up at a low single-digit rate and pricing power is pretty tepid, which results in that type of sequential pressure?

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Robert T. O’Shaughnessy, PulteGroup, Inc. - Executive VP & CFO [13]

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Yes.

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Ryan R. Marshall, PulteGroup, Inc. - President, CEO & Director [14]

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Go ahead Bob.

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Robert T. O’Shaughnessy, PulteGroup, Inc. - Executive VP & CFO [15]

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Alan, it's important to remember we are still near 23%, so the margin profile is pretty strong. But the market is challenging right now, price is a little bit harder to come by. We have a lot of companies that have much more inventory on the ground that they're trying to work through. And so we are working -- we've highlighted in the prepared remarks, we are interested in selling homes, and so we're willing to toggle price to do that to a degree. Also mix does matter, you highlighted that, and we highlighted that we pulled some closings or were able to close homes in California. And so on a relative basis, we'll have a less of those higher margin closings in Q2 than we did in Q1, which will matter. And then the relative percentage between the active adult and the traditional business may moderate a little bit. So we're, candidly, pretty pleased with the margins that we're expecting for the second quarter. And again, it is reflective of the fact that the market is a little challenging right now for price.

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Alan S. Ratner, Zelman & Associates LLC - MD [16]

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Got it. That's helpful -- and yes, certainly the absolute margins are very strong. I just wanted to better understand kind of what went into your thought process there. Second, just a couple of housekeeping questions on the American West deal if I could. It sounds like there is no active communities or backlog that's coming over? I just want to confirm that that's correct, because you're not anticipating deliveries until 2020. And then I guess the follow-up there is, why was this the right deal? Why Las Vegas? Is there something specific about that lot position or their price point positioning there that's attractive to you guys? And should we expect more of this type of deal going forward?

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Ryan R. Marshall, PulteGroup, Inc. - President, CEO & Director [17]

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Yes, it's Ryan. Good morning. A couple of things there. First, with American West, we did acquire active communities, we did not acquire backlog, and so that's why we've highlighted that we'll start closing homes in early 2020. Secondarily, to your second question, we like Las Vegas, we've got a nice operation there. We have had historic success in Vegas. We like the positioning of where these communities are located. They are in a very favorable part of town relative to the job core, the transportation network, and so we like that. We like, frankly, the value that these communities offer to consumers on a price per foot and what you get for the price you're paying. We think American West has done a very nice job positioning these communities, and so that was attractive to us as well. Maybe the third and fourth items that I'd highlight: we like what it does to our relative market share in Las Vegas, which is something that we've highlighted as key to our success, and finally, we like the nature of how this transaction was constructed, in that we get a little less than 2 years' worth of owned lots and we have a great pipeline of future lots that are under option. So kind of all things considered, we think it was a very good transaction, and we're excited to have the American West brand part of our family.

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Operator [18]

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

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Kenneth Robinson Zener, KeyBanc Capital Markets Inc., Research Division - Director and Equity Research Analyst [19]

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Hello. Yes, can you hear me now?

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Ryan R. Marshall, PulteGroup, Inc. - President, CEO & Director [20]

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Yes.

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Kenneth Robinson Zener, KeyBanc Capital Markets Inc., Research Division - Director and Equity Research Analyst [21]

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Excellent. So Ryan, Bob, I know you guys talked about orders, order pace being down year-over-year. We do look at it, model it sequentially. You have a long history of pace going up about 40% sequentially in 1Q. You did about 50%, so higher than a standard deviation basically. Why don't -- when you talk about April, and I don't want to focus on a couple of weeks, but when did you really start to feel comfortable that these orders were coming through? Was it really just March, A? And then, B, how did that play out in the pricing dynamic you might have seen within the spec units that ended up coming better? And why did you deliver more in California? That's my only question here.

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Ryan R. Marshall, PulteGroup, Inc. - President, CEO & Director [22]

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Yes, Ken. In fairness, I think there were 3 embedded in there, but I'll answer all of them. First off, let me maybe speak to the California question. We've got a great team in California that I think has done a nice job getting some complicated buildings built in a complicated entitlement market. And so some of that was just our own internal planning and assessing associated risks with getting those homes closed. So I think we did a nice job with that. The other 2 pieces -- yes, so in terms of kind of pricing and when we saw things start to really accelerate, we've long said, and maybe the industry has long said, that Super Bowl tends to be kind of the time of the year when you start to see the spring selling season start to kick in. And I think that held true this year, and then we continued to see things strengthen as we moved throughout the quarter. So we're pleased with that. As far as kind of pricing power, I think I'd point back to some of the things that Bob touched on. It's competitive, and there are some competitors out there that have put a lot of inventory on the ground and so consumers have choices. And within that environment, we're making sure that we're toggling associated discounts and incentives such that we're getting our share of the buyers that are out there willing to buy. And I think we're -- as demonstrated by the absorptions in Q1, I think we struck the right balance between pace and price, where we've got a healthy and attractive margin profile, but we also were able to sell homes.

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Operator [23]

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

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Nishu Sood, Deutsche Bank AG, Research Division - Director [24]

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Thank you. Your balance sheet looks in great shape now, with the cash flow generation of last year, your net debt-to-cap sub-30. Thinking about cash flow deployment this year, obviously, the American West acquisition will consume some of it. How do you expect the kind of remainder of cash flow to be allocated? Do you expect to keep up the pace of cash returns to shareholders through buybacks and dividends, or would the American West acquisition, either prevent that or maybe indicate additional acquisitions to come?

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Robert T. O’Shaughnessy, PulteGroup, Inc. - Executive VP & CFO [25]

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Yes, Nishu, it's Bob. Thank you, great question. I'll point you back to what we've been saying for years now, which is no change to our capital allocation strategy or processes. Expect us first to invest in the business. We had guided to $1.2 billion of land acquisition spend this year, which is about the same as we did last year. Obviously, that excludes American West, so that American West spend would be on top of that. And after that, we will certainly look at our capital in the same way we always have. We'll pay our dividend. We'll buy back stock if we have excess. We'll look at our leverage if it make sense. So nothing new to report there and nothing really -- we've also told folks is we'll tell you when we've done it, as opposed to what we think we are going to do, so no guidance in terms of dollar spend on anything other than the land.

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Nishu Sood, Deutsche Bank AG, Research Division - Director [26]

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Got it, got it, okay. And on SG&A, the 11% to 11.5%, I believe you mentioned for 2Q. There was some modest deleveraging in 1Q. And I know that closings will be down a little more year-over-year, but it seems like more significant deleveraging than what we saw in 1Q. Are there any one-off factors that are driving that? Or how should we think about the kind of acceleration in the SG&A deleveraging in 2Q '19?

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Robert T. O’Shaughnessy, PulteGroup, Inc. - Executive VP & CFO [27]

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Well, I think it's really -- there are no kind of unique aspects to that, other than that our expense structure typically comes pretty ratably whereas the closings could can be a little lumpy, for lack of better word. And so relative to our guide in the first quarter, we closed more houses that we thought would close in the second quarter. And so really it was a little bit of a pull forward of revenue into Q1. So Q2, the spend is still there, but some of the revenue dollars came in Q1.

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Operator [28]

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And your next question comes from the line of John Lovallo with Bank of America.

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John Lovallo, BofA Merrill Lynch, Research Division - VP [29]

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The first one on -- Texas was a bright spot versus our expectations. Can you give us an idea of what kind of areas you saw the most strength, perhaps the receptivity to Centex and maybe the opportunities for Centex to roll out into other markets?

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Ryan R. Marshall, PulteGroup, Inc. - President, CEO & Director [30]

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Yes, John, it's Ryan. Texas was a bright spot for us. We're in all 4 major cities in Texas: Austin, Dallas, Houston, San Antonio. I would tell you that all 4 cities performed well. Of the 4, Austin is arguably the strongest, and I think that's really being driven by the continued job creation and high-quality jobs that are being created in Austin, which is fueling further housing need. Second to Austin, I'd highlight Houston; our senior team, Bob and I, we were just in the Texas markets a couple of weeks ago. So we saw it firsthand, there are some nice things going on economically in Houston as well. And I think you're continuing to see that city really get back on its feet following the flooding and the hurricanes that they experienced 1.5 years ago. So -- and then Dallas also very strong, but it is seeing a run up in pricing, affordability has been certainly -- the affordability equation there is not as attractive as what it used to be, but lots of people there, good economy, jobs are being created. And then, finally, San Antonio is a stable, kind of a steady-as-she-goes market, and we really like the business that we're seeing there. So on the whole, Texas was a favorable bright spot for us, as you highlighted.

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John Lovallo, BofA Merrill Lynch, Research Division - VP [31]

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Okay, that's helpful. And then on the cost side, did you guys benefit from lumber in the quarter? And is there any update on just kind of labor -- trade labor in general, if you're seeing any loosening there or about the same?

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Robert T. O’Shaughnessy, PulteGroup, Inc. - Executive VP & CFO [32]

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Yes, certainly, lumber was a little bit of a benefit in Q1, as we had highlighted on our fourth quarter call, that will be more of a Q2 and Q3 issue for us. Important to remember that lumber is only 3% to 5% of the total vertical construction cost. So it's a -- while it will benefit us, it's not a -- an overly significant element of the house construction cost. Labor is obviously one of the larger ones, and we had highlighted, coming into the year, roughly a 2% increase or expectation for increase in our material and labor input costs and we still see that as the case for the balance of the year. So, you know, that's with the relative save on lumber later in the year. So not a really aggressive pricing environment. And obviously, we've got our teams working to try and drive those costs down, labor being one of the areas we're looking at.

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Operator [33]

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

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Michael Jason Rehaut, JP Morgan Chase & Co, Research Division - Senior Analyst [34]

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The first question I had was on trends during the quarter, because appreciate you giving the 2Q guidance, but at the same time you held off on the full year guidance, I guess wanting to see more of how the spring came together or will continue to come together. And so it kind of implied a little bit of a question mark as we closed things out. I was just curious if that was result of any type of continued volatility, let's say, month-to-month during the quarter? Because you have obviously indicated that it seems like things kind of progressed in somewhat more of an orderly pace, with traffic improving every month, even up year-over-year, and it seems like you had some amount of, I don't know if stability is the right word, but kind of a decent cadence. So I'd love to get color on -- sales pace, I believe, was down 8% on average for the quarter itself. Was there volatility on a year-over-year basis as we progressed January, February, March? If there could be any color around that sales pace metric in particular or any other areas of volatility that you might want to highlight, that would be helpful.

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Ryan R. Marshall, PulteGroup, Inc. - President, CEO & Director [35]

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Yes, Mike, it's Ryan. As I -- I think I'll point back to some of the comments or reiterate some of the comments I made in the prepared remarks. We saw the quarter really play out where each month got stronger both sequentially and on a year-over-year basis. As we highlighted, the absorption rates were still down relative to Q1, but that was as much reflective of a very strong 2018. No intra-quarter volatility that I would point to. We've given our guide for Q2. We've highlighted that we'll give you our full year guide at the end of Q2. The one thing that I would probably highlight and note for you is that last year it was kind of the third quarter of April, fourth quarter of April when we started to see a slowdown, and we talked about that on our Q2 call last year. So that's -- you know, that's probably the one thing that we're continuing to kind of watch and pay attention to. In addition to that, as both Bob and I have mentioned, it's still competitive out there, so we like how the market is performing, but there is some inventory, there is some discounting going on. And so for those reasons, we've elected to wait until the end of Q2.

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Michael Jason Rehaut, JP Morgan Chase & Co, Research Division - Senior Analyst [36]

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Okay. I appreciate that. And I guess, just to clarify, when you say improvement throughout the quarter, if that applies to the sales pace improving on a year-over-year basis as well? If I can just get that clarification. And then just going back to American West for a second. I believe they are currently operating around a dozen communities, just want to get that right. And the closings number, at least in 2017, as Builder magazine has it, was a little over 600. If we're talking about that type of a scale in terms of how you think about what they could contribute on an annualized basis?

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Ryan R. Marshall, PulteGroup, Inc. - President, CEO & Director [37]

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Yes, 11 active communities, Mike, is what we plan to have there. And as we mentioned, we will see closings in 2020 is when we'll start to see things from that business. In terms of kind of your question on what did we see as we moved through the quarter, we were down in absorption rates year-over-year. So there was a decline, but things got stronger as we moved through the quarter.

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Operator [38]

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Your next question comes from the line of Carl Reichardt with BTIG.

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Carl Edwin Reichardt, BTIG, LLC, Research Division - MD [39]

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I wanted to ask about pricing power, or what there is or lack of incentive use just among the different product types. So I think we have a sense of it from geographic standpoint, but if you compare active adult, move-up and first-time in the mix, Ryan, where are you seeing the best performance in terms of lack of incentives or perhaps pricing power?

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Ryan R. Marshall, PulteGroup, Inc. - President, CEO & Director [40]

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Well, Carl, I think we'd continued to highlight that the best performer for us is in active adult. That's a buyer group, A, that I think has generally fared well economically in the current environment. They are not nearly as sensitive on interest rates as what the other 2 buyer groups are. They've typically got an accumulation of wealth. And then we've got a very compelling offering and unique offering with our Del Webb communities that we think is differentiated in the marketplace and I think that gives us some pricing power. With the other 2 groups, I'd probably characterize them as equal in terms of discounting, but for different reasons. The move-up buyer has got choice, and there's generally speaking more inventory on the ground for that buyer to choose from. So I think that's a driver for added incentives, and with the first-time entry-level buyer, they're tending -- there's more of an affordability pinch there that is creating the need for incentives. So best, active adult, the other 2 probably being equal.

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Operator [41]

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Your next question comes from the line of Matthew Bouley with Barclays.

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Matthew Adrien Bouley, Barclays Bank PLC, Research Division - VP [42]

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I wanted to follow-up on the comments you made around spec margins. Specifically, to what degree would you say that the higher spec you carried into the quarter played into that 4% sales discount you disclosed, the up 80 basis points year-over-year? And so, as you've started to now normalize the spec position, what would be the implication to incentives, I guess, going forward?

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Robert T. O’Shaughnessy, PulteGroup, Inc. - Executive VP & CFO [43]

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Yes, I don't think we have that level of granularity for you today. The thing I'd highlight for you is over time what we have seen is the margins that we realized on homes -- and think discount as being part of this -- if we sell it as dirt or if we sell it before basically frame -- are roughly the same, even if it was started as spec. Where we start to see degradation in margin is when we get them final.

And so, as you can tell, we don't have a ton of final inventory on the ground, it was 662, I think, finished spec at the end of the quarter, which is up maybe 50 or 60 over last year. So we didn't let a lot of it get to that. And so, I would tell you it's probably not a significant driver. In answering your question, it's not a significant driver, the discount differential on spec versus non-spec production.

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Matthew Adrien Bouley, Barclays Bank PLC, Research Division - VP [44]

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Okay, that's helpful. And then secondly, just bigger picture, on the land spend comments. You grew your land spend in the quarter, but it sounds like you're keeping the '19 guidance around $1.2 billion before American West. So, just given the market has improved since that initial guidance, I mean would there be any kind of rethinking or perhaps upside to that land spend target. Kind of what are your thoughts around, I guess, ongoing unit growth targets at this stage in the cycle?

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Ryan R. Marshall, PulteGroup, Inc. - President, CEO & Director [45]

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Yes, at this point in time, we're not giving any kind of additional guide beyond the $1.2 billion that we've highlighted. But I would note that, essentially, the American West transaction is an investment in land, 1,200 or so finished lots that we'll get today and another 2,400 plus or minus option lots. So those are incremental lots beyond the guide that we had initially given and will also be incremental spend. So I think I would read into that that we are optimistic and bullish on the future.

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Operator [46]

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Your next question comes from the line of Susan Maklari with Crédit Suisse.

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Susan Marie Maklari, Crédit Suisse AG, Research Division - Research Analyst [47]

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My first question is around Del Webb. You definitely saw some more strength in that part of the business this quarter, and it's an area where you've done a lot of work over the last, call it, a year or 2 in sort of repositioning or redesigning those communities to some extent. So how much of the strength this quarter would you attribute to the company's specific efforts versus just the broader market and the shifts in demand?

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Ryan R. Marshall, PulteGroup, Inc. - President, CEO & Director [48]

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Yes, Susan, I think it's probably broader than just saying the last 1.5 years. This is an effort that really goes back to when we rolled out our very first commonly managed plans, which happened to be specifically designed for our Del Webb communities. That work goes back to kind of end of 2013, '14 timeframe. We've highlighted that we're now, 5 years after that initial rollout, we're in the process of rolling out our next-generation Del Webb plans. So we think we've done a really nice job with the product meeting the needs of this particular buyer. I think some of the things that you're alluding to are reflective of smaller communities, and when I say smaller, these are on the order of 750 to 1,200 units relative to some of the larger size Del Webb communities that we had from a prior timeframe, where they could be as large as 3,000, 4,000, 5,000 homes in size and scale. So I think it's a combination of how the brand has continued to evolve to keep up with how that buyer has evolved. The communities are a little smaller, and that's really been driven by a desire for these buyers to work longer, have access to the amenities, the country clubs, the churches, the entertainment that they are used to in their current market, as opposed to selling their family home and moving out of state to an entirely different destination. So hard to pinpoint it down to a timeframe of the last 6, 12 or 18 months, but it's really been an evolution over the last 6 to 7 years.

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Susan Marie Maklari, Crédit Suisse AG, Research Division - Research Analyst [49]

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Okay, thank you. And then my next question is just, you know, you talked a little bit to the strength that you did see in terms of some of the options and the lot premiums in the quarter. Is there any sort of change you would say that you've seen there in terms of what people are choosing, or any preference over one thing versus another that you could share with us?

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Ryan R. Marshall, PulteGroup, Inc. - President, CEO & Director [50]

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Nothing that I would highlight other than we think that the way that we are running our pricing model, we're doing a nice job of giving consumers choice and allowing them to spend money on the things that they value. Lot premiums continue to be something that we get great benefit out of, and we think the consumer does as well. Unique lot premiums, there are typically only a small number of those in a given community, and so if a buyer has an opportunity to buy those, there's certainly value for the consumer and for us as we sell those. Option spend, we continue to see probably some of the most popular things be the personal choice items around flooring, around cabinets, countertops, some structural options as consumers kind of customize or personalize the things that they want in their home. Those are the things where we're seeing buyers spend money.

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Operator [51]

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Your next question comes from the line of Jack Micenko with SIG.

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John Gregory Micenko, Susquehanna Financial Group, LLLP, Research Division - Deputy Director of Research [52]

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Ryan -- or Bob, I think you said that incentives were up about 80 basis points year-over-year. I'm more curious if you could give us a sense of what incentives maybe did through the quarter. I know you'd said pricing, the pricing environment was still tough. But is there any directional sense or color you can give us on incentive trends and even maybe into April?

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Robert T. O’Shaughnessy, PulteGroup, Inc. - Executive VP & CFO [53]

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Jack, nothing meaningful in terms of differentials during the quarter, candidly.

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John Gregory Micenko, Susquehanna Financial Group, LLLP, Research Division - Deputy Director of Research [54]

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Okay, okay. And then on the land side, I think in the slide you call it a 54% option component, and I think that's been in 40s in prior years. So just could you give us an update around mix? I know you're still at the 3-year number, working that down, but with 61% owned but doing more option, where do we see that number getting to, inclusive of America West, over like the next year or 2, would you say?

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Robert T. O’Shaughnessy, PulteGroup, Inc. - Executive VP & CFO [55]

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I don't want to give a target. But the American West, obviously, 67% of the lots are controlled via option and the 1,200 that we bought, Ryan highlighted 2 years of supply, they're finished. Looking at the book, we have highlighted that we're at 3.9 years, 39% controlled in total via option. But if you take out some of those legacy Del Webb positions, you're closer to 3.3 years of owned and almost 50-50 owned versus optioned. So I think there are opportunities, but not significant movement from here. I think if you look back over the last 4, 5 years, we've been operating at close to that 3 years owned and 3 years optioned. I think you continue -- you will continue to see that from us going forward. Obviously, American West is an opportunity that was -- allowed us do a little bit better than that. And we'll seek other opportunities as we go forward.

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Operator [56]

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Your next question comes from the line of Paul Przybylski with Wells Fargo.

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Paul Allen Przybylski, Wells Fargo Securities, LLC, Research Division - Associate Analyst [57]

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Going back to Del Webb. Did you see a normal seasonality in orders this quarter, or was there a later start to the selling season and maybe some carry through into March and April given the 4Q pause that buyer had?

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Robert T. O’Shaughnessy, PulteGroup, Inc. - Executive VP & CFO [58]

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Yes, nothing that I would highlight, Paul, as unique or abnormal.

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Paul Allen Przybylski, Wells Fargo Securities, LLC, Research Division - Associate Analyst [59]

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Okay. And then what percent of your communities had price increases versus the...

(technical difficulty)

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Robert T. O’Shaughnessy, PulteGroup, Inc. - Executive VP & CFO [60]

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I don't know that, Paul, we can try and do a little work for you.

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Operator [61]

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There are no further questions at this time. I'd like to turn the call back over to our presenters for closing remarks.

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James P. Zeumer, PulteGroup, Inc. - VP of IR & Corporate Communications [62]

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Great. Thank you, Jack. Appreciate everybody's time this morning. We're certainly available as the day goes along for any additional questions, and we will look forward to speaking with you on our next conference calls.

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Operator [63]

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This concludes the Q1 2019 PulteGroup, Inc., Earnings Conference Call. We thank you for your participation. You may now disconnect.