Lennar Corp (LEN) 2004 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to the second quarter earnings release call for Lennar Corporation.

At this time all participants are in a listen-only mode.

Later we will conduct a question-and-answer session and instructions will be given at that time.

Should you require assistance during today's call, please press star then 0 and an operator will assist you offline.

As a reminder, this conference is being recorded.

I would now like to read the disclaimer regarding forward-looking statements.

The information that Lennar Corporation is going to discuss will include forward-looking statements.

As is always the case with regard to forward-looking statements, Lennar's actual results may differ materially those that are projected in the forward-looking statements.

There are discussion in Lennar's annual report on form 10-K and the quarterly reports on form 10-Q which have been filed with the Securities and Exchange Commission of factors that would cause actual results to differ materially from those projected in the forward-looking statements.

The company urges you to look at them.

I would now like to turn the conference over to our host, President and CEO, Stuart Miller.

Please go ahead.

Thank you and good morning, everybody.

We would like to welcome you to Lennar's second quarter conference call.

Joining me here today we have a fairly large group.

But management team is in town, I just want to say that we have our Chief Operating Officer, Mr. Strudler who is here joining us for management meetings in Miami and, of course, Mr. Strudler is the strength behind the numbers in operations in the company.

We have Bruce Gross, our Chief Financial Officer who will be giving a broader range of focus on our numbers in just a couple of minutes.

John Jaffe who comes from our Western region and governs our entire Western operations and is responsible for our growth in California.

And David McCain, President of Lennar Financial Services.

At the same time, we have Controller, Diane Bessette and Treasurer, Waynewright Malcolm that are here with us as well.

So with those introductions, let me go on and tell you a little bit about our strategy and our quarter and, of course, Bruce will come on after me to give some more color to the numbers.

As you can see from our press release, we're very pleased to bring you our quarterly results, which again represent another report quarter for our company as we move on to another record year as expected in 2004.

And as you see from our guidance, we're increasing our guidance again for fiscal year 2004 to $5.50 a share.

And an increase in revenues over our last year record of 11% has translated into a 26% increase in net earnings and a 20% increase in earnings per share.

At the same time, margins continue to increase some 70 basis points.

Somewhat offset by SG&A increase, which Bruce is going to give a little bit more color on in just a couple of minutes, but that primarily relates to the land sales that we saw in the second quarter.

Perhaps most important in our numbers is the continued strength that we see in our sales pace which reflected a 17% growth rate over last year's record pace and it reflects the fact that both demand and traffic are still very strong in the marketplace.

Even in light of recent interest rate tickups.

And even as we have tempered our sales pace in order to catch up with construction, we have continued to grow our backlog which is up 39% over last year's record backlog to $5.9 billion and that gives us excellent visibility to another record level performance in year 2004 and into 2005.

And as I said before, accordingly, we are raising our fiscal year '04 guidance to $5.50 given this visibility.

As noted also, our financial services ARM, Lennar Financial Services is showing an expected down performance year-over-year and this, of course, reflects the impact of a rising interest rate environment and its impact on the refinance business.

This reduction has been anticipated and is included, of course, in our guidance for this year.

Counterbalancing some of the negative impact from financial services has been the very positive impact of the pared down land strategy in the wake of the Newhall announcement which we made last year at this time and, of course, the subsequent closing of that very exciting program last quarter.

As we noted with the acquisition of Newhall, we adhered to a time-tested growth strategy of paring down assets in the wake of new strategic acquisitions and that is exactly what we have done.

Accordingly, we have rebalanced our land portfolio by selling some of the land assets which we viewed as less strategic in the wake of the Newhall acquisition.

In spite of the profitability that we have seen from these asset sales, the replacement property, the Newhall transaction is arguably not only more strategic for the company and for our future, but also potentially much more profitable in the long term than the assets that we have sold.

In the wake of the Newhall transaction and our pare-down strategy, our total number of home sites owned and controlled has in fact increased 25% year-over-year from Q2 '03 to Q2 '04 and this, of course, not only covers our ability to provide home sites for current production for fiscal year '04 and all the way through '05, but positions us well with 2-3 years of land owned and controlled for deliveries well beyond '05.

And this land position is and continues to be very well positioned in the fastest growing markets in the states where land continues to be a most constrained resource.

As a final note, let me say that as we look ahead we're not only encouraged by our strong backlog and our very strong balance sheet, we're also encouraged by the challenges in the marketplace that favor growth for the largest and best capitalized home builders in the country.

Land, as I have noted, continues to be in very short supply and is becoming more and more capital-intensive requiring more and more sophistication.

The larger builders will continue to prevail in the acquisition of the most strategic properties located in the most constrained markets across the country.

At the same time, commodity price fluctuations and labor price increases will continue to be counterbalanced by process improvement and both purchases in the largest companies where size can be brought to bear on best practices and the biggest companies, of course, will be able to harvest the benefits of those size advantages and sophistication advantages.

We, of course, continue to be encouraged by our overall growth strategy of balancing strong organic growth with our time-tested and focused acquisition strategy that will continue to facilitate Lennar's growth as the homebuilding industry continues to consolidate and we grew into the future.

So with that, let me turn over to Bruce who will give additional color on the numbers for the company.

Thank you, Stuart and good morning.

I'm proud to again report record earnings for our company during this quarter.

The 26% increase in earnings versus the prior year is just one component.

However, our scorecard is driven by our business model which we call the "Lennar Process" which focuses on three components: Strong earnings, high returns on capital, and a strengthening balance sheet.

Our return on net capital was 22.1%, and the return on beginning equity was 33%, both looking at the trailing four quarters.

We achieved the strong earnings and high returns as our balance sheet leverage improved with net debt to total capital decreasing from 34.5% to 29.5%.

Our earnings success was noted both in homebuilding and land, while financial services adjusted to the higher interest rates, as Stuart mentioned.

Home deliveries for the quarter were up 5%, and this is in line with our comments from the first quarter conference call when we noted that your deliveries would be more back-loaded in 2004.

The average sales price increased during the quarter to 266,000 from 257,000 in the prior year.

And the breakdown by region is as follows: The East region average sales price was 246,000, which is flat with the prior year.

The Central region increased from 197,000 in the prior year to 199,000.

And the West region was up from 317,000 in the prior year to 335,000 in the current year.

And a more challenging environment of rising costs, building material shortages, we were successful in increasing gross margins 70 basis points, as we managed rising costs with the combination of pricing power and improved building efficiencies.

While gross margins were strong in all three of our regions, we continue to see the greatest strength in the most land-constrained markets, such as, California, New Jersey, Maryland, Virginia, Nevada, Florida, and Minnesota.

The markets which are on the softer side continue to be Texas and the Carolinas.

As Stuart mentioned, new orders were up 17% during the quarter and the market strength from a new order perspective is the same as noted above with gross margins.

Our cancellation rate for the quarter remained at the low end of the normal range that we've established in the past and that is a range of 20-30%.

Our average community count for the quarter was 754 communities, and that compares to an average of 732 communities in the prior year.

In addition to our homebuilding divisions having an excellent quarter, our land divisions had a record quarter as well.

As we focused on paring down assets, which is the normal part of our business process and as you can see land revenues increased over 100% year-over-year and the gross profit before SG&A expenses increased from 13 million in the prior year to 56 million in the current year's quarter.

The largest land sale was in the East region, however, there were contributions from all three regions with the total of 2,200 home sites sold and 600 acres sold as well.

Although we pared down assets, we continue to position the company for future growth as our home sites owned and controlled increased from 182,000 in the prior year's quarter to 227,000 in the current quarter.

The percentage of owned home sites decreased to 38% with 62% controlled as we continue to focus on return on capital.

Our joint venture activity increased from 11.3 million to 14 million in the current year's quarter, while management fees and other increased from 5.3 million to 18.7 million.

Management fees and other were higher due primarily to the sale of an option contract to buy home sites which was part of a pare-down strategy to sell half the home sites controlled in a specific community.

Additionally, we had an increase in management fee income [ph] during the quarter.

Selling, general and administrative costs increased as a percent of home sale revenue from 11.3% to 12.1%.

SG&A includes costs from both our homebuilding and our land divisions.

The increase is primarily due to additional bonus costs that are due to the higher level of land sales that we had during the quarter.

As you know, we are required to accrue bonus expense consistent with the timing of land sale profit.

However, we expect to see a reduction in SG&A percent in the fourth quarter of this year, as our land sale profit will be significantly below the prior year's fourth quarter land sale profit.

Turning to financial services.

We earned 32.3 million, compared with 37.2 million in the prior year.

As previously indicated, we have been in a robust refinance environment that has bolstered both our Eagle Mortgage and our North American Title operations in the past.

Additionally, as refinance activity has declined significantly from the prior year, the mortgage business becomes a little bit more competitive initially as loan agents principally focused on refinance activity or are switching to the purchase business, as well as the percentage of variable loans increasing which are less profitable than fixed-rate loans.

On the mortgage side, our Universal American Mortgage Company, operating earnings 15.2 million versus 18.7 million in the prior year, a 19% decrease.

Our Lennar home buyer capture rate was 71%, compared with 73% in the prior year's quarter.

Our goal by the fourth quarter of this year is to have a capture rate of 75% or higher and we're expecting to see the benefit as we focus on a higher capture rate in some of our recent acquisitions.

Eagle Mortgage is the most sensitive to the refinance slowdown and the Eagle Mortgage operating earnings decreased to 1.8 million from 6 million in the prior year.

Total mortgage originations for our mortgage operations were 1.8 billion versus 1.9 billion in the prior year, and our average loan amount was 218,000 versus 208,000 in the prior year for loans to Lennar home buyers.

Our fixed rate mortgages decreased to approximately 70% from 83% in the prior year, and our title operating earnings decreased to 9.2 million from 11.8 million in the prior year, which also is due to refinance slow down.

As we indicated in the first quarter conference call, we plan to monetize alarm or cable subscriber contracts in this quarter in our strategic technologies division.

We did monetize the majority of alarm subscriber contracts resulting in a $6 million pretax profit.

Although we did not monetize any cable subscribers this quarter, we did continue to grow our cable subscribers to 6,900 from 5,100 in the prior year's quarter.

We also continue to focus on growing our personal lines insurance business which showed a $200,000 profit versus 100,000 in the prior year and, additionally in this quarter, our diluted share count was impacted by 9 million shares representing our dilution for our contingent convertible security, whereas in the prior year, the dilution did not impact our share count until the third quarter.

Turning to the balance sheet.

During the quarter the company issued $300 million of floating rate notes at LIBOR plus 75.

The proceeds were used to pay down more expensive Term Loan B financing, and additionally we increased our credit facility commitment to $1.2 billion with 25 banks and extended the maturity out to 2009.

Our shareholders equity increased by $1 billion over the prior year's second quarter to $3.5 billion of equity.

Our credit ratios also improved on a trailing fourth quarter basis as EBIT to interest incurred improved to 11.4 times from 8.6 times in the prior year, and net-debt to EBIT improved to 0.7 from 1.0 in the prior year.

The company had approximately 140 million of cash at quarter-end, and 0 outstanding on its 1.2 billion revolving credit facilities.

As we have been maintaining a large cash balance, we strategically invested approximately $400 million in the early takedown of home sites that otherwise would have been taken down over the short-term with escalations to their land price.

Our strategy remains to option longer term land takedowns and remaining focused on mitigation of risk and return on capital.

In this quarter Moodies and Fitch both revised the company's credit outlook to positive.

In this quarter we also completed and our auditors have reviewed our catchup analysis of JV and options controlled that might require a consolidation under FIN 46.

As you may recall, this quarter we were required to evaluate and consolidate as necessary the pre-February 1st, 2003 JV and option contracts.

The impact to our balance sheet was not significant.

It was under $100 million and the total inventory consolidated not owned is now 224 million that you will see on the balance sheet with the reporting of our 10-Q.

Turning to the goals for 2004.

As we look forward, we are really confident with this year.

We have the benefit of looking at our backlog, which as Stuart mentioned, was up 39% and is at 5.9 billion.

This gives us not only visibility into this year, but it makes us confident as we look beyond this year.

As a result of reviewing this backlog, we are increasing our earnings per share from 5.30 to 5.50 per share.

Homebuilding is right on track to deliver 37,000 deliveries, as we've indicated previously, with improving margins which also are partially offset by the lower financial services results that we have been talking about today.

As we adjust the impact to LSS, which is a third quarter timed event, we are adjusting our goals to $1.30 in the third quarter and a range of 2.10 to 2.15 in the fourth quarter.

More specifically, our financial services operations, we are reducing our 2004 operating earnings in that division to approximately 125 million which is about a $20 million reduction.

The third quarter we would estimate at about 28 million of operating earnings and financial services, while the fourth quarter is expected to improve to 42 million as a result of focusing on improved capture rate, which we expect to be in the mid-70% range and a greater number of Lennar home deliveries as well.

Home deliveries are expected to be up approximately 20% year-over-year in both the third and fourth quarters of this year.

New orders are expected to increase at a slower pace than we have seen this year due to our slowing the sales pace for construction to catch up with our very strong backlog position.

Average sales prices are increasing and we estimate approximately 270,000 in the third quarter and 280,000 in the fourth quarter.

Our gross margin is also improving with the third quarter looking at similar year-over-year margins.

However, in the fourth quarter, we are anticipating that our gross margin should exceed 25%.

The combined category of land, joint venture and management fees will be flattish in the third quarter year-over-year at about 38 million.

However, in the fourth quarter the combined total we are expecting will be closer to the $25 million range, which will be considerably below last year's 91 million in the fourth quarter.

Our dilutive share count we expect to be around 167 million shares, and we remain extremely confident looking forward into 2005 as well, as we'll provide more details, updated goals for 2005 on our third quarter conference call.

Which, by the way, as a result of some of the holidays in September, we are planning our call for September 20th at 11:00 Eastern time.

With that, we'd like to open it up for any of your questions.

Thank you.

Ladies and gentlemen, if you wish to ask a question, please press star then 1 at this time.

You will hear a tone indicating you have been placed in queue.

You may remove yourself from the queue at any time by pressing the pound key.

If using a speaker phone, please pick up your handset before pressing the numbers.

We do ask that you limit your question to 1 question and 1 follow-up.

We'll go to the line of Myron Kaplan from Kaplan, Nathan & Company.

Please go ahead.

Great quarter, guys.

Thanks.

Good morning, Myron.

Good morning, sir.

Congratulations.

I wanted to ask you, last quarter you bought some shares and wanted to ask you if you had purchased any additional?

No, I think you will see that there are no additional purchases.

Right, I didn't see it in the reports.

Do you see any trends in the markets in Texas and so forth that show any strengthening or are they just continuing to be just so-so?

I think so far the trend in Texas has been kind of flat.

It has been down.

It has been a little bit on the sluggish side and we haven't seen any real strengthening in that marketplace.

All right.

Thank you.

Thank you.

We will next go to the line of Michael Rehaut from J.P. Morgan.

Please go ahead.

Yeah, hi.

Good morning.

Just wanted to know if you had any comment on the KPMG tax shelter article this morning?

And I just had a follow-up question also on the lot position?

Sure, Mike.

What came out this morning, which was a strategy known as class, this is a strategy that Lennar did implement and it was a tax deferral, not a tax avoiding strategy.

We implemented it in 2000, and Lennar as always has made all the appropriate disclosures pursuant to the IRS requirements.

This is not a situation where there are any penalties, and Lennar continues to focus and attempt to resolve this issue with the IRS.

This was a very small number, by the way, as well.

It might have been larger for some of the other companies.

But again, it was a deferral, it was not a tax avoidance program.

You're in talks right now to resolve it, but at this point there are no penalties or is that something that as you resolve it you will get better clarity on that?

No, there are no penalties in the situation.

Okay.

And again, it's a deferral situation, it wasn't an avoidance, it's something that we are continuing to work with the IRS and we fully disclosed, as you can see in all of our prior reports.

Okay.

And the amount of the deferral is, would you say it is like under 20 million, 10 million or is that something you can't comment on?

I would say that the number is very small relative to our balance sheet, and it is very insignificant as far as that number goes.

Okay.

On the lot position, you had a nice increase this quarter.

I was wondering if you could give some idea what drove that and if there are any geographic areas that those lots -- I assume a lot of those would be option lots, but if you could give us some detail, the nature of the lots, geographic area.

If you look at the increase that you're referring to, going up to 227,000 total home sites owned and controlled, we have seen a continued increase as we have been growing our positions in our markets and we did increase our positions in markets such as Florida, California, and other markets that are supply constrained, which position us well for the future.

They are not in any markets other than the markets you're familiar with from the past.

So it is a continuation of our growth strategy.

Okay.

And the 182 comparison, was that from the first quarter of this year or the second quarter of last year?

That is compared to the second quarter of last year.

Okay.

Perfect.

Thanks a lot.

We will next go to the line of Steve Kim from Smith Barney.

Please go ahead.

Hi.

It's Jed Barron for Steve Kim.

Congratulations on the quarter.

Thank you, Jed.

Just a question on the SG&A that you were discussing earlier.

I just wanted to make sure I understood this a little better.

In terms of, when you said that the increase in the SG&A was partially coming from the homebuilding, partially coming from the land divisions.

When you talk about the land divisions, I assume you are talking about things such as Lennar Land Partners, along those lines, and as you book additional sales through there you recognize some of the expense in SG&A through your homebuilding expense line?

No, let's go back for a second.

We have separate homebuilding and land divisions in our company.

Lennar Land Partners is a separate joint venture, so that is not included in any of the numbers we are referring to.

What we are looking at is because we had a large number of land sales in the second quarter of this year, we're required to match the appropriate bonus accrual expense tied to those land sales, which were very large this quarter, whereas last year it was very large in the fourth quarter.

So in accruing that, we had a higher SG&A expense and we compare that to a denominator of home sale revenue, and therefore it is weighted.

The entire amount is due to additional land sale personnel-related costs and we do expect to see a declining SG&A percentage as we get to the fourth quarter of this year and it reverses where we have a much smaller land sale profit compared to the prior year.

Okay.

All right.

That's -- okay.

That makes sense.

Then, I guess, just quickly as a follow-up.

Have you guys sort of targeted a subcount growth rate for this year?

Where you think you might be operating in terms of subdivisions by year end?

Community count, again, we look at average communities.

Right.

As we are looking forward.

And, these, again I just want to caution they bounce around and sometimes you sell at a faster pace and they close quicker and sometimes you get the reverse scenario where you could have more communities for a different reason because maybe there is slower sales.

But as we look forward for this year, I would expect at the end of this year that we're going to be somewhere in the low- to mid-800 range as far as community count.

Okay.

Perfect.

Thanks very much.

Thank you.

We will now go to the line of Todd Vencil from BB&T Capital Markets.

Please go ahead.

Gentlemen, good morning.

Morning.

I'm wondering if you could just maybe give some color on whatever the most recent sort of period is that you might want to talk about in terms of traffic and deposits or sales or, however, you want to think about it.

Whether you want to talk about since the end of the quarter, or maybe the last few weeks of the quarter just in terms of relative trends to previous periods?

I think that in remaining consistent we certainly don't want to speak beyond the quarter.

We never have and I don't think it is good practice to start that now.

Looking at the quarter, you see some pretty consistent traffic and demand patterns throughout the second quarter and I think you're hearing that pretty consistently from all of the larger homebuilders.

We continue to see a very strong pace of sales that is primarily driven by demand.

I think as you look ahead and as we look ahead, we are really looking at tapering back some of the sales pace by way of raising prices just to keep our backlog in pace with construction.

We certainly don't want to get too far ahead of ourselves and I think that again you're seeing that across the industry.

So, demand patterns and traffic patterns remain very, very strong.

That has been the indication that we see from the marketplace.

And I think, again, you're hearing that consistently from a number of the larger builders.

Okay.

Thanks for that.

And I appreciate sort of the heads up on what might be viewed as slowing sales pace and I hope that avoids any confusion.

Right.

In the quarters, if and when that does end up happening.

And Bruce, I just want to clarify what I think I heard.

Did you basically just say that the entire increase in SG&A was due to the bonus accrual on the land sales or if not can you kind of tell me how much of that was with the land sale related versus home sales?

Sure, the entire increase was due to land personnel cost increases with the vast majority of that being an increase in the bonus accrual.

Got it.

Thanks very much.

You're welcome.

Thank you.

We will now go to the line of Ivy Zelman with CSFB.

Please go ahead.

Good morning, guys.

Actually Dennis on behalf of Ivy.

The conversion ratio that you guys were referring to slowing down the order pace to catch up on construction.

That is not reflected here in the second quarter, right?

You're speaking more going forward?

Meaning you didn't slow down the order pace in the second quarter?

No, actually as we said at the end of the first quarter, we felt that it was important to pull back a little bit on the sales pace and as we went into the second quarter we actually did increase prices a little bit more aggressively to maintain a sales pace that was a little bit closer to construction.

Still, as we see our backlog building up, we are again focused on making sure that we are keeping our sales pace close to construction pace and again pricing power, raising prices is a good mechanism to bring down the sales pace a little more.

Was the conversion ratio abnormally high this time a year-ago?

Because just looking at the three regions, the Central region is really where we saw the step-up of the conversion and maybe the catchup there with the construction cycle, but that is also the region where orders have been a little bit weaker the last couple quarters.

One of the things you're seeing also, Dennis, is as you are looking at conversion ratio, is it is continuing to become a little bit more difficult to bring on communities and this is something across the industry, and that is something that all of the builders have been struggling with.

It is tougher in the local municipalities to bring on the community counts as you open up for sale to be able to start construction on a timely basis.

We could have offsetting factors there and still see the conversion ratio down versus a year ago.

Right.

And as you refer to conversion ratio, you're referring to the backlog conversion ratio, right?

Correct, yeah.

Yeah.

And then just lastly, could you drill down on some of you Texas markets specifically, you talked broadly that you haven't seen improving trends.

Is that in most of the markets that you're in there or are there are some differences that you're seeing?

This is Bob Strudler.

In looking at the Texas market as a whole, as Stuart commented, we've seen no real change in the marketplace.

As you look at each of the markets, Dallas is still maintaining a sales pace comparable to last year with no rebound.

Austin is very competitive at this point in time.

I think probably the stronger market in Texas is probably San Antonio, which seems to have a little more resilience.

We have a lot of competition in the northern [ph] markets with all the builders there.

So there has been real no rebound in any of the three markets.

San Antonio would probably be the strongest of all.

Okay.

And then just lastly, have you needed to incentivize any more to kind of get the volume there is?

And if so -- or just in general, where do the incentives fall?

Is that in SG&A or is that in COGS?

Incentives in our reporting show up as a reduction to the sales price.

Okay.

And the incentives in Texas this quarter compared with the same quarter last year hasn't really increased.

It is about the same level so what we're saying is that, it was a little bit of a slower market last year and it continues to be about the same this year.

Okay.

Thank you very much, guys.

Yep.

Thank you.

We will now go to the line of Margaret Whelan from UBS.

Please go ahead.

Hi, guys.

Good morning.

I have three questions.

The first one, I don't want to harp on about land sales because I actually think, in general, it is irrelevant whether you sell a house or whether you sell real land.

But can you just give us an idea of which markets you were selling in, and how long have you been holding land on the West Coast versus the East Coast or the Midwest and that kind of thing.

Margaret, you're fading out there.

What was the end of the question?

I'm trying to figure out the land that you're holding on to.

The land that you're selling where is it and the land that you're holding on to, how long do you hold land on the East Coast versus the West Coast?

It is really a broad-based strategy, Margaret, and I think that in terms of which land we're selling, which land we're holding on to and length of period of time, all of these questions are really return on capital focused and are much more dependent on additional land positions that we have in any given market rather than any kind of strategic view of one geography versus another.

In the constrained markets, we are looking to balance out positions of land held, either held or controlled, to where we have a solid three to six year supply of land or visibility.

And to the extent that we find new opportunities that might be more or less strategic, we are constantly rebalancing our land portfolio in strategic markets.

The Newhall acquisition is certainly a good example of that.

It afforded us the opportunity to rebalance and sort of rethink some of the strategic positions that we held.

And the sale of land positions in a variety of marketplaces reflected what was a new balanced position, newly balanced position with the Newhall program in California, and we think that that is a stronger position than any of the positions that we have sold in the past probably six to nine months.

And remember that the land strategy that is now kind of coming out in the numbers is one that was put in place almost 9 months to 12 months ago as we announced the Newhall program, recognizing that the pare-down strategy would go hand in hand with the acquisition.

I'm comfortable with it and why you're doing it.

I just am wondering, you're saying that you are making these decisions based on return in capital, but we don't actually know what the return in capital is, because you're giving us the gross margin on the land and then your homebuilding EBIT margin is being cut by the incentive bonuses for the sales, so how can we get an EBIT margin on land sales, the return on capital on the land sales?

As you're looking to separate out a return on capital just on our land divisions, it is not something that you can actually dissect from our financial statements, Margaret.

But, as we look at it, we run our business both with separate homebuilding divisions and separate land divisions and each of those divisions have specific return on capital targets and bonus programs and that is how they are compensated, incentivized and that is how we decide whether to make a sale or not.

We're looking at return on capital in each specific transaction.

Lennar Homes has a separate land division, but you can't give us the EBIT for it, is that what you're saying?

Lennar Homes will have separate homebuilding divisions and separate land divisions.

Yeah.

Internally we look at those separately.

But as we report externally, you don't see those because there is deferral of land profit that will flow through gross margin that just doesn't show up in land sales.

Typically is the EBIT margin on the land sales greater or lower than on the homebuilding?

It will vary market by market and it will really depend in part on how much is actually flowing through at any given home in time.

Again, what you're seeing in this year has been a reflection of a strategy that was employed relative to a large land transaction.

And also this year what you're seeing is the strength of prior land acquisition strategies that have been put in place where perhaps the continuing holding of those land parcels is not as strategic as the new acquisition that we made.

But just like any of our homebuilding divisions, we don't separately report on our land division to the public and we don't break those out.

Okay.

And the second question I had, a couple of your peers and now yourselves, you are slowing down your conversion ratio and recognizing the absolute number of homes you're delivering keeps going up, but most of you have goals to double in size over the next 5-6 years and what do you think might be a constraint on that growth if you're already slowing it down?

I recognize that you're raising prices and you're raising margins, but are you going to be able to double in size?

Do you have the human resources and the systems in place that do that?

I think that we have the systems and controls and people in place to be able to continue to grow the business and grow at a very steady pace and certainly the sales pace over the past five years has been admirable and something that we think that we can continue comfortably.

I think that one of the constraints on growth is the constraint on the ability to bring on the next land opportunity or the next construction program relative to the approval process.

The approval process has become a slower process.

The municipalities have dragged their feet a little bit in the midst of no-growth sentiments.

And, therefore, as we deliver more homes and sell homes quicker, we can't just turn on the spigot as quickly as we would like to of bringing new production in line.

It takes a little more time for the new production, the new land parcels to become approved and ready to go.

So there is a little bit of catchup that takes place that is going take place across the industry from time to time, but that doesn't mean that over a two, three, or four quarter period there won't be that catchup and we are certainly seeing that right now, as we look at our fourth quarter we're certainly seeing that we're going to be able to catch up a piece of that as we go forward.

Okay.

Do you think going forward there will be less seasonality to your earnings if you're managing the sales process a little more efficiently?

I'm going to say no, because I think that you're still going to see great deal of your demand come through in the seasonally attractive times of the year.

And I don't think that we will manage our sales process to the point that we miss the selling season and have product available in the slower times of the year.

I think that there will continue to be seasonality.

Okay.

And then I just had a final question for Bruce.

If it was at all possible to look like on an apples-to-apples basis at homes you were selling last year versus this year, can you put a dollar number on the absolute cost increases that you are seeing on some timber and some of your raw materials.

Some of your peers said it was around $3,000.

Yeah.

It is not a number that for the company that we could put out there, and a lot of that reason is we have a large percentage of homes, for example, that come from Florida where we don't use wood in our framing operation, we use steel.

Yes.

So it is not really a number that we give overall for the company, but in specific markets you are seeing increases in lumber at that level or higher.

And then, are you seeing cement shortages in Florida?

I'm sorry?

Are you seeing a cement shortage in Florida?

Are feeling that?

There is absolutely a cement shortage in Florida, however, this is one of the areas that as being a large builder we are able to manage through that and we are not being impacted at this point as a result of the size that we have in the marketplace.

Okay.

Thank you very much, guys.

Thanks, Margaret.

Thank you.

We'll next go to the line of Carl Reichardt from Wachovia Securities.

Please go ahead.

Good morning, guys.

Good morning.

Two questions.

First, the interest expense included in cost of goods for this quarter and then for last year, do you have that number, Bruce?

And do you have it broken out between home sales and land and lot sales?

I do.

The interest expense number in total for this year was 30 million.

And in the prior year's second quarter was 36 million.

And the portion that is in sales of homes was approximately 29 million this year and 35 million last year.

Great.

Thank you.

And then my follow-up is related to the takedown of land.

I think you mentioned 400 million because you had taken down some options, putting them on balance sheet with land because you had some escalation clauses.

Do you look at the 140,000 or whatever it is options that you control right now, what percentage of those are subject to price escalation clauses over time?

The portion that are options generally will all have escalation clauses.

All of them?

If it's an option that you're taking down over time, typically there will be an escalation claus,e and what we did is we stepped back and said, we have a large cash balance let's look at the shortest term, highest escalations to try to bring those in in the short-term as much as possible as a good use of our short-term cash.

Sure.

That makes sense.

Can you give me just a rough sense of what would be a short enough term, large enough escalation that would cause you to bring it on balance sheet versus an average one?

Well, figure a 1 to 2 years, Carl, and even a 7-8% escalation over the course of a year would be an attractive use of cash given the certainty that is embedded in the delivery of that home site.

Okay.

And the fact that our cash sitting on balance sheet is only going to generate somewhere around 1% in terms of return.

Right.

Okay.

Yeah.

I'm not arguing that you did it.

I'm just curious how the numbers look in terms of the portfolio of options, but that helps me.

Thank a lot, guys.

Okay, you bet.

You're welcome.

Thank you.

We will next go to the line of Tim Jones from Wasserman & Associates.

Please go ahead.

Good morning.

Hi, Tim.

Good morning.

Nice to hear the golden throat there, too, Mr. Strudler.

First of all, did you just say that your escalation clauses are running 7-8% or is that a hypothetical?

It is a hypothetical.

They vary a pretty wide range, so you really couldn't quantify --

What would you say they average?

I would have thought they would average less than that.

They probably do average less than that, but we have some at a higher escalation rate and those would be the ones that we would tend to target in terms of taking down the shorter range of the home sites.

Those would be the ones in Florida and California?

They might be in a variety of places.

There are a number of places where land is very desirable and in very short supply and that is where you would have higher escalation clauses, so whether it is Washington, D.C. or Nevada or elsewhere, you're going to find a number of places where the escalation clause might be a little bit different.

In your statement, I think you said that the most of that big land sales was in the East since you are buying land in Florida, am I to suspect that most of the land sales were in the New Jersey area?

The Jersey, Washington, D.C., that area?

No, I think that our land sales were pretty broad-based and pretty much around in a number of different locations.

It wasn't concentrated in the Northeast.

No, they were not concentrated in the Northeast.

Okay.

And lastly, is the city of Boca Raton was putting in some sidewalks and it took a month for them to -- from the time they made the bid to finish the job because they said there was no cement available.

They could not get it.

Took them a month to buy.

The Rinker's [ph] truck finally showed up yesterday and it only was half full.

They keep blaming some kind of dam in Japan that is 7-miles wide or something.

And how serious is this problem?

Talking to them they said it was quite serious, though they said the prices of cement and ready mix has started to come down?

This is a very sad tale of woe, Tim.

Putting that aside, I think one of the advantages to size is starting to reveal itself relative to the shortage of concrete.

You mean the big dog gets fed first?

Bruce would be happy to hear that.

But, yes, that is in fact the case.

And the larger builders are able to schedule the availability of concrete and it is becoming more and more difficult for some of the lessor users to be able to count on the availability of concrete.

It was in short supply.

It was critical for the city and they are not a small user so it is something I guess to keep your eye on.

Is there anything to that thing, that the shortage is due to this dam in Japan that is 7-miles long, that they have just been pouring cement in for the last six months?

We have heard a number of stories.

I've also heard that it is because of the demand for cement in China.

Yeah, I heard that one, also.

Where it is actually coming from, I don't know that we can put our finger on it, but the fact is that it is in short supply and it is --

But you're covered for the next year or six months?

Yes.

We feel that we're covered.

Thank you.

Thank you.

Thank you.

We will next go to the line of Jim Wilson from JMP Securities.

Please go ahead.

Thanks.

I know it has been an hour, so I will keep it short.

Sort of wondering if you could comment a little bit on who you are seeing as land buyers as you're selling excess land?

And then sort of the second part or issue is, you looked strategically at the cash, I know I have asked this before, but is strategy a little bit be cautious with the rates going up and look for maybe what might end up being better priced land acquisition opportunities in '05 conceivably, or is that too general a comment to make?

Let me take the last one, the second question first, Jim.

No, I think that would be -- the strategy is not to sell off land and look for better opportunities in '05.

We maintain the fact that land is a constrained commodity in our business.

And we think that land pricing is likely going to stay high in the most competitive and constrained markets as we go forward.

So we don't think that there are going to be opportunities in the future to buy additional land.

In terms of cash strategy, we have adopted a short-term strategy of deploying cash where we think that there is a very, very high certainty of delivery.

That is simply an arbitrage strategy.

Making sure that we are taking 1% money and turning it into 5 or 6 or 7% money where there is very low risk involved.

But still from a balance sheet standpoint and a liquidity standpoint, our company is focused on growth and growth opportunities.

We continue to be focused on making sure that we have the liquidity to react, given any market conditions in a continuing growing housing market.

We want to be at the front end of growth both organically and acquisitively.

And should the market pull back, we want to be well-positioned to take advantage of opportunities as they might exist or present themselves.

Okay, great.

Thanks.

That's what I was thinking.

All right, great quarter.

Thank you.

Thank you.

Thank you.

We'll next go to the line of Steve Fockens with Lehman Brothers.

Please go ahead.

Hi.

Good morning, guys.

Just a couple quick housekeeping items.

Bruce, in terms of as we think about land, gross profit over the rest of the year, are we looking at levels similar to the first half or third quarter of last year?

I'm assuming you are expecting a big slowdown in terms of gross profit versus the first half of the year?

I would say that the gross profit is going down and again as you look at the third quarter there is two things happening.

One, the revenue is going to be lower.

And the gross profit should be lower than you saw in the second quarter of this year.

And then in the fourth quarter, revenue will be significantly lower and margins will be more in the range of what we saw last year than you saw in the second quarter.

Okay.

But that means then -- does that still mean then for the full year you're going to have a much bigger land year this year than last year?

Well, last year if you look at the combination of the three categories of land, joint venture, management fees and other, we had a combined number that was 177 million of operating earnings from that combined group.

And I would say this year that you're going to be probably closer to maybe 210 million or so from that combined group.

So it hasn't increased considerably, but it will be higher.

Okay.

And then in terms of the orders as you guys have described sort of a slowing pace.

Can you put some idea of magnitude around that?

Are we talking a low-single digit order growth rate in the back half of the year?

Something in the teens?

Just kind of an order of magnitude around what you're thinking when you say slower?

We are not really solving to a number.

What we're trying to do is artfully match construction and sales and backlogs so that we are delivering in an orderly fashion.

Therefore, there is something organic in that calculation that we're going to have to wait and see.

I don't want to peg our future numbers to any given number at this point.

But understand that what we are doing is we're matching our delivery system with the sales pace, and as you can see from the backlog growth there is some catchup to be done.

But maybe to put that another way, given that you are expecting a big pickup on the closings in the back half, I would imagine that starts to eat into that backlog to the extent that whatever slowing you're talking about in orders, this is a relatively short-term phenomenon?

It is a relatively short-term phenomenon and we are confident that as we get to year-end we're going to have a backlog that matches up well with where we think deliveries are supposed to be for '05.

Okay, great.

And then lastly, that sort of leads into a longer-term question which is, if you look back at how you guys did back from '98 to 2000 when the rates were moving up, through the early point of that period your orders were still rising and then by towards the end of '99 they were flat or down, but if I remember correctly part of that was your own decision to slow down orders in the belief that the overall market was slowing.

If today is a repeat of then and who knows, but over the next year, year and a half, that the macro market really slows somewhat, do you expect to pull back your own order pace?

Or do you expect to say, look, we're going to be able to grow through this no matter what and we we're going to continue to invest in the business such that through a rising rate environment, we're still going to see some level of order growth?

A very interesting question.

I think that you have to go back to the philosophy that we adhere to and that is, we keep one foot on the accelerator and one on the brake at all times and we're always playing to current market conditions.

It's not that we feel we're going to grow through anything.

We're certainly not going to be able to do something different than the momentum of the marketplace will allow us to do.

I think that we're going to continue to match up sales pace with construction delivery systems and to the extent that we see demand wane we're going to pull back a little bit.

As you look back into 1999, you're right, there was some pullback and we kept our program very closely tied to where the market was actually performing and that, of course, set us up to do what we think was one of the great transactions in the industry and that was the U.S. home [ph] transaction.

Is that a way of saying you might employ a similar strategy this time around?

Some of the other builders have said, unless the overall market falls dramatically and we all believe this is a market share game over time.

If the overall demand pattern slows, we view that as a good opportunity to really continue to push our advantage over smaller builds and continue to invest such that several years out we're just building that many more units.

Am I right in saying that your approach is more, let's really see what the market does, but if it really starts to turn around again and where maybe not as many communities or investments we thought, that that's the right time to look at buying somebody?

Well, there are so many opportunities in what could potentially be a slowing environment that pigeon holing ourselves or pointing to any one of those opportunities would be almost impossible to do.

At a moment of a slowdown, the pulling back on the delivery system might mean actually finding new land opportunities that could present themselves, it could be the opportunity to buy smaller builders or larger builders.

It might simply be the opportunity to reinvestigate and remanage the cost system that exists within the overall structure using the size that we have acquired to really be able to negotiate with the trade at that point.

The real point that we make is, given any environment, whether it's a high-growth environment, a strong housing market, or a pulled back market, we try to remain nimble and as attuned to the market trying to identify opportunities in a real-time way at a given moment in time and not trying to limit ourselves to a box approach to, this is what we are going to do if such and such happens.

Because the hypotheticals can vary so much.

Fair enough.

So maybe put another way, you manage the nimbleness so that you can pull many different levers to still continue to grow your company and your earnings no matter the environment?

That's exactly what we think the Lennar advantage is.

Okay.

Is with multiple levers.

As we grow our business, it is organic, it's also acquisitive, we are constantly focused on process and we use the strength of our balance sheet, the liquidity in our balance sheet to give us that position.

Okay.

Thank you very much.

Thank you, I think we have time for one more question.

Thank you.

We will open the line of Rick Murray from Raymond James.

Please go ahead.

Good afternoon, guys.

Nice quarter.

Thank you.

Thank you.

Just a few real quick questions here.

Would you be able to -- I know someone asked it earlier, but would you be able to quantify the progression of order activity during the quarter?

As we went through the quarter, order activity remained pretty strong all the way through.

If you looked at comparisons year-over-year, that would probably -- it moved around a little bit as we went through the quarter.

Mostly because comparison weeks were different.

But as we looked through the quarter we had relative strength all the way through.

Okay.

Great.

My other question is in terms of the credit quality of the buyers you are seeing today, can you talk a little bit about the average FICO score that you're seeing and how that compares to the prior year?

David, why don't you go ahead and take that.

The average FICO score is becoming a little more challenged.

It is flattish but it is trending slightly downward.

Do you have a number?

No, we don't have a number for that.

Okay.

Thanks.

I guess my last question, Stuart, perhaps you're best suited to answer this.

With regard to your early exercise of your land options and your comments that that is probably a return of 7-8% versus the 1% you're earning in the money market, why not buy back stock given that you have not too long ago purchased stock at or below or even above actually current levels.

I mean surely the return potential that you would earn on that has to be greater than 7 or 8%.

Good question.

I think that there is a significant difference in the repurchase of stock and the purchase of the land assets that we have undertaken to purchase.

Again, we view our mandate as a company to grow the business.

We think that growth opportunities will present themselves and be very desirable.

We think that the growth strategy of the company is going to reflect itself in cost reductions and a variety of other opportunities in the future.

The land acquisition strategy is a very short-term strategy with a short-term return of that liquidity to the company which will continue to facilitate the growth of the company.

A stock repurchase program, though, I agree with you, it falls exactly as you suggest, we have repurchased stock at higher levels.

We could repurchase stock at lower levels.

It is nevertheless a long-term negative liquidity program which is contrast to our strategy of growing the company overall.

I would point out that our strategy of buying back stock, as we have seen in the past, has been pretty closely tied to keeping our number of shares outstanding at a constant pace as opposed to an actual stock buyback program to reduce the number of shares.

So, again, keeping our strategy pure, we're looking primarily at growing the company and making sure that we have the liquidity in good times or even in pullback scenarios to be able to grow the company and do interesting things for the future.

Thank you very much.

Okay.

Thank you.

I think that that will just about wrap it up for today.

We have gone past the 12:00 hour.

I did want to thank everybody for joining us today.

And we look forward in September to reporting again on our third quarter performance.

Thank you.

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