Lennar Corp (LEN) 2006 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to the Lennar Corporation first quarter earnings conference call.

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

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

If you do need assistance during the call today, please press the star followed by the 0 and an Operator will help you offline.

We will begin today's conference call with a Safe Harbor disclaimer on forward-looking statements.

Today's conference call may include forward-looking statements that are subject to risks and uncertainties relating to Lennar's future financial and business performance.

These forward-looking statements may include statements regarding our business, financial condition, results of operations, cash flows, strategies and prospects.

Forward-looking statements represent the Company's estimates only on the date of this conference call and are not intended to give any assurance as to the actual future results.

Because forward-looking statements relate to matters that have not yet occurred these statements are inherently subject to risks and uncertainties.

Many factors could cause our actual activities or results to differ materially from the activities and results anticipated in forward-looking statements.

These factors include those described under the caption "Risk Factors Relating to Our Business" contained in our Annual Report on Form 10-K for our most recently completed fiscal year which is on file with the SEC.

Please note that Lennar assumes no obligation to update any forward-looking statement from past or present filings and conference calls.

With that being said, I'd like the turn the conference over to Mr. Stuart Miller.

Please go ahead, sir.

Good morning, everyone.

Thanks for joining us.

Would like to welcome you to Lennar's first quarter conference call.

We're very pleased to be able to share our progress and perspectives of the homebuilding industry with you this morning.

As always I'm joined with Bruce Gross, our Chief Financial Officer, who will give a detailed financial overview after I give some introductory comments.

After Bruce's remarks I'd like to beg everyone's indulgence as we try to run an orderly question-and-answer program.

We've had some comments in the past that we would be benefited by very much limiting to one question and one follow-up, so we'd really like to ask that we all adhere to that protocol.

Let me begin by saying that we're very pleased to report a very healthy first quarter for 2006.

We continue to be optimistic about continued success and performance for the remainder of this year and into 2007.

As you can see from our press release, revenues, net earnings and earnings per share were all up approximately 34, 35% while margins and new orders were up marginally year-over-year.

Our healthy backlog of $7.1 billion positions us to continue to perform throughout this year, while reasonable market conditions give us confidence that even the currently cooling housing market conditions will afford us an opportunity to perform well in 2007 as well.

Perhaps the biggest question right now in the industry is the question of what of market conditions, how has it been, where is the market going, and how will the market affect our business going forward?

To begin, as you've heard from all of the homebuilders reporting, market conditions have been slower in many of our major markets across the country.

Not only have price escalations slowed materially in most markets, but traffic has been cooling down as well.

These slower conditions, however, have not amounted to the feared bursting of the bubble or a meltdown in the industry.

To the contrary, the slowdown has been more of a cooling off period.

And as we progress through the quarter, we've already begun to see some recovery in the traffic patterns in many of our major markets.

Our strategy as we have navigated these market conditions has been to use locally crafted strategies in a measured and orderly fashion to keep inventory levels very low while keeping our homebuilding machine working.

This has meant using a combination of incentives, broker participations, price reductions or just price maintenance as appropriate given local market conditions.

Price and cost strategies have been carefully mapped out by local management while they've been working with corporate executives.

Concurrently, cost side management programs have also been initiated to offset some of the incentives used to stay connected to the current market conditions.

We have maintained a focus on land sellers and building partners and suppliers as we have looked to share the impact of incentives recognizing that we are all partners in the process of pricing our product to current conditions.

On the land side we have already received numerous concessions from options sellers who recognize that it is in our mutual interest to remain in step with an adjusting market.

On the building partner side we are seeing a slower adjustment given the still strong volume of production, but the first conversations have begun.

The bottom line is that there will be an impact on margin as we move through the year, but we are not yet in a position to accurately determine what the extent of the margin erosion will ultimately be.

We are currently anticipating an impact in the 100 basis point range for the year.

As we look ahead, we believe that market conditions are generally favorable for a fairly soft correction in the homebuilding world.

The fundamentals that drive our business continue to be strong.

Interest rates are still low by all historical measures, unemployment is low, job formation remains strong in most markets, and the economy is reasonably strong as well.

Inventories are generally low and constrained and limited by the constrained and short land supply.

While there remains some inventory overhang from speculators in some of the markets that has seen the greatest price increases over the past years, population and job growth and the generally healthy economy will likely help absorb this overhang in a very short period of time as traffic continues to improve.

Strategically, Lennar continues to be well positioned in all of our markets with land positions and open communities well positioned for growth and earnings for our Company.

Additionally, as market conditions continue to reveal themselves, we have many arrows in our quiver to continue to position our Company for current and future record-breaking performance.

As always, our strong balance sheet position, reflected by our current rating agency upgrade from Moody's to Baa2, positions our Company extremely well to adjust to the market as it moves and shifts and for new opportunities as they present themselves.

We have always said that we use a strong balance sheet first approach to our business so that cyclical shifts can be an ally not an adversary for our business.

As a final thought, I'd like to welcome Rick Beckwitt to the executive ranks of our Company.

In continuing our effort to strengthen the position of our Company and the day-to-day corporate oversight of our division operations, we were fortunate to attract a truly seasoned executive of Rick's caliber to our team.

Rick will oversee day-to-day operations on the Eastern side of the United States, and will bring his vast operational as well as M&A experience to the executive administration of Lennar.

In conclusion, let me say that we are very optimistic about 2006 and beyond.

While market conditions will continue to adjust and evolve, we feel that we are extremely well positioned to perform well given our very strong market position, our very strong balance sheet, and an ever more focused and determined management team.

Now let me turnover to Bruce for a financial review.

Thank you, Stuart, and good morning, everybody.

Our scorecard for the first quarter 2006 once again highlights the three components of our strategy.

First, strong growth as noted with our 35% increase in earnings per share, second, while generating a strong return on net capital which was 22% for the trailing four quarters, and third, maintaining a strong liquid balance sheet as our debt to total capital was 36%.

Homebuilding operating earnings were up 36% primarily as a result of exceeding our delivery goals as well as a 30 basis point gross margin improvement in our year-over-year gross margin percentage.

Wholly owned deliveries increased 18% year-over-year and the increase was noted in all three of our operating regions.

Our average sales price increased 12% year-over-year from 292,000 to 326,000 with the regional breakout as follows: the Eastern region was up 22% from 271,000 to 329,000 with the largest increase coming from Florida, our Central region was down 1% to 191,000 and our Western region was up 14% from 376,000 to 430,000.

The gross margin percentage improved in the Eastern region primarily to improvements in the Florida marketplaces as a result of favorable pricing conditions throughout the state.

The Central and West regions partially offset the improvement in the East as a result -- that was due to in the increase in sales incentives which very considerably from not only market-to-market but community-to-community and home-to-home.

The more supply constrained markets in our marketplaces continued to deliver the highest gross margin percentages for the Company.

The SG&A percentage as a percent of revenue from home sales was up 60 basis points versus the prior year.

This increase was primarily due to higher personnel related costs resulting from an increase in the number of land divisions.

We increased the number of land divisions this year and as a result we have increased the number of home sites owned and controlled, which are up from 283,000 in the first quarter of last year, to 345,000 in the first quarter this year, as well as we have increased land sales activity coming from these land divisions.

During the quarter we began classifying management fees from joint ventures as management fee income instead of an offset against SG&A.

Additionally, we incurred approximately a $0.02 charge in the first quarter for the expensing of stock options.

This is the first quarter that we've started to expense stock options as required and it is reflected in both the SG&A line as well as the corporate G&A line as well.

Gross profit on land sales during the quarter were 49.1 million versus 23.5 million in the prior period and the land sale activity was primarily in both the East and the West regions.

Our joint venture profits increased to 38.2 million from 16.1 million in the prior year's quarter.

Lennar's profit related to the homebuilding activity in joint ventures was 8.4 million versus 9.5 million in the prior year's quarter.

Financial services pretax was 10.6 million versus 16.3 million in the first quarter of the prior year, and our mortgage profit was 8.7 million and that compared with 11.6 million in the prior year.

Our mortgage capture rate was 62%, and that compares with 70% in the prior year as we're still operating in a very competitive mortgage marketplace.

Of the mortgages that we do capture, however, the fixed component increased in the first quarter and is now 58% of the total versus 42% for variable type mortgage products.

However, keep in mind that 90% approximately of these variable loan products are fixed for between three to 10 years.

In this quarter we did not have any pay option loan product in our mix whereas in the first quarter of 2005 that represented 8% of the total mortgages to our home buying customers.

FICO scores did not change significantly from the prior year and remain in the low 700 range, and our title pretax decreased in the first quarter which is always the lowest quarter for title to 1 million pretax from 5.2 million in the prior year as our volume and profit transaction decreased.

Turning to the balance sheet, again, I'd like to reiterate what Stuart said.

We are pleased that Moody's did recognize our long-term history of strong revenue and earnings growth, healthy liquidity and our disciplined operating strategy, as they upgraded us to Baa2 and we still remain a balance sheet first focused company.

In addition to our low balance sheet leverage in the first quarter, we generated EBIT of approximately 454 million, a 33% increase over the prior year, and our EBIT to interest coverage improved to 13.1 times coverage.

Our debt to EBIT leverage was one times coverage for both years, and these calculations are on a rolling four quarter basis.

We did exercise the accordion feature of our revolving credit facility during the quarter increasing the capacity from 1.7 billion to 2.2 billion, and during the quarter we did not repurchase any shares of stock.

Our new homeowners, including joint ventures during the quarter and this is net of cancellations, were up 4% year-over-year, and there was strength in the three regions that we operate.

Our cancellation rate was 24% during the quarter, our backlog dollar value increased 18% year-over-year, and just for those of you that like to roll forward our backlog, we did acquire a few communities during the quarter that did add 399 homes to our backlog.

These were primarily in the West region and primarily in the joint venture category.

The wholly owned backlog average sales price was 360,000 which increased to 8% over the prior year's first quarter backlog.

Turning to our EPS goal for 2006, we are reaffirming our $9.25 EPS goal for 2006.

I'd like to highlight five items that we are updating with respect to this EPS goal.

First deliveries.

Although there's a slowing sales pace in many of our markets, we remain disciplined in matching our sales and construction pace, and in fact, we are increasing our delivery goal by approximately 500 homes for 2006 to 48,750.

In prior years our deliveries were more back loaded in the year.

However, we believe this upside will occur in the second quarter of our year as our homebuilding manufacturing plan is running efficiently.

The increase of 500 homes is an increase of 750 wholly owned deliveries partially offset by a 250 home decrease from the joint venture category.

The second item I'd like to highlight is gross margins, and as Stuart mentioned, we expect that our gross margins for the entire year will be down about 100 basis points to about 25%.

We believe that the second quarter of this year will decrease sequentially from the first quarter about 50 basis points, and then increase 50 basis points, again, sequentially in Q3 and another 50 basis points sequentially in Q4.

The increases in the second half of the year tied directly into the strategy being managed in our local markets that Stuart described earlier.

The third item I'd like to highlight are land sales, joint ventures and management fees.

Our land asset management divisions are well positioned with attractive land holdings and are focused on increasing the land sales activity.

Therefore, we are increasing our gross profit from land sales this year to approximately 270 million for 2006.

When looking at the total of land sale profit, joint venture profit and management fee income on a combined basis, we now expect to have approximately 495 million combined in 2006, and that compares with last year's 434 million combined for those three categories.

The fourth item I'd like to highlight is SG&A as a percentage of home sales.

We do expect that to increase to approximately 11.6% and the largest portion of this increase is due to land division SG&A which is increasing as our land sales activity is increasing as well.

Additionally, we are expecting an increase in broker commissions and is advertising in this year and that's due to the slower sales pace environment that we talked about earlier.

These SG&A numbers do not include an offset for management fees.

Management fees are now on the management fee income and other line.

And then finally, share count, although we did not repurchase any shares in the first quarter, we are estimates that our average share count for 2006 will be approximately 163 million shares.

This is about 2.5 million shares below our prior estimate as we do anticipate repurchasing some shares during the year as we did over the last couple of years.

We previously provided EPS goal ranges by quarter, and we suggest using these as guidelines to end up at $9.25 for the year, noting that the nature of land sale profits can shift from quarter to quarter thereby adjusting these ranges.

The range for the second quarter was $1.90 to $2, the third quarter, 2.40 to 2.50, and the fourth quarter $3.30 to 3.40.

The upside in the first quarter did pull forward activity from quarters three and four.

Although we're still in the range that we previously set forth for Q3 and Q4, we are now closer to the low end of that range due to pulling that activity forward into the first quarter.

In summary, we are proud to report these strong results and we remain well positioned to achieve our earnings per share goals for this year while also generating a high return on capital and managing a strong balance sheet.

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

[OPERATOR INSTRUCTIONS]

Our first question comes from the line of Stephen Kim with Citigroup.

Please go ahead.

Thanks, guys.

Good quarter in a tough environment.

Thanks, Steve.

I guess my first question related to the increase in your land divisions.

Can you talk a little bit about from a practical perspective what that means on the ground and how you expect that to pay back over the course of the next couple of years?

Just give us more color in granularity on that?

Well, as you know, Steve, our land position continues to be one of the strongest assets, one of the strongest programs that we have in the Company, and has always set us apart within the industry.

We've always viewed that part of our business as an important part of the Lennar franchise.

You know, our land position is very carefully constructed.

We have some of the best land professionals in the industry that have moved forward in structuring kind of a three-pronged approach, the purchasing side of the equation is very carefully crafted with a lot of due diligence and a lot of expertise brought to bear.

We also have used structuring techniques as an opportunity to diversify our risk, making sure that we bring in strategic partners, and then we've used a pare down strategy to also balance our risk and to position our land extremely well.

As you see our land asset move around as it grows, as it pares down, I think that as we are balance sheet first focused, that land asset is really the strength of the Company and is consistently being pruned and cared for to make sure that it remains the envy of the industry.

Okay.

I guess I'd love to follow-up with that but there's a more pressing question that I wanted to ask you.

Maybe I'll queue back in on that.

The gross margins, you've given some pretty specific guidance sequentially.

I guess my question is generally speaking your Company's gross margin expands over the course of the year, typically seems like your first quarter is the lowest gross margin in the year.

So I could just chalk up the increases in Q3 and Q4 sequentially to that.

However, you made a comment, I think Bruce made a comment about how you expected to see some of the benefit from some of the dynamics or initiatives that Stuart eluded to before.

So I'm recalling that Stuart, that you mentioned something along the lines of trying to renegotiate some of your land options, deposits and also sort of dealing with some of your subtrades to get better terms.

Should I understand from your gross margin guidance that you are factoring in future concessions from some of your building partners in this number or is this a number that is not really incorporating some benefit you may get there?

I think there are a lot of moving parts, Steve.

Sure.

And, you know, mix is going to have a lot to do with things both on the selling price side and as well on the concessions side.

Some of the concessions that have been brought about by the market are going to fall into the second, the third, the fourth quarter in some mixture.

Likewise, the concessions that our either building partners or the land sellers are likely to bring to the table, and as I said we've seen some of that.

We think there's going to be more partnering and sharing of the concessions.

Actually when they will fall into place is going to be a little bit up in the air.

But we are factoring an expectation of additional incentives into our numbers and that's basically an extrapolation of what we've already seen in terms of our approach to many of these people.

I just want to make sure I understood your answer.

So you're saying that you're factoring in some maybe additional incentives that you're going to have to give, but you're not factoring in some concessions you're going to receive from your building partners in your guidance?

Is that what you're saying?

No.

I'm saying that I think that we're factoring on both sides.

Okay.

On the concessions from land and building partners, what we're factoring in is basically an extrapolation of what we've already seen.

We think that we're going to continue to have a lot of the same success that's going forward.

Okay.

I see.

Thanks.

You bet.

Thank you.

Thank you.

We have a question from the line of Rob Stephenson with Morgan Stanley.

Please go ahead.

Good morning, guys.

Can you talk about what the cancellation rates were on homes actually under construction and how that compares versus recent years and historical averages?

Sure.

The cancellation rate during the quarter was 24%, Rob, and what we have said for many years is that our typical cancellation rate is in the 20 to 30%.

However, over the last couple of years we've been running just under the 20% mark, which is below the typical average of the past, so 24% is a little higher, but it is in the range that we've considered normal over many years.

But is that you losing people to not getting mortgage qualification?

I mean what was the people who, you know, the home actually started construction and they wound up cancelling on you at that point?

Well, there is --

Has that changed dramatically over the past year?

Well, in the fourth quarter, Rob, we were at approximately 23% fourth quarter of '05.

So it's just a tick up from there and it's really different in each market.

When you do have a change in the market as we just have seen, is when you typically do see a little bit of a bump up in the cancellation rate as people are rethinking.

Just to add to that if I could.

I don't think that there has been a substantial difference in the percentage of cancellations we've had in homes under construction versus homes to be built.

I think it's been across the board, and I think that good part of the reason that we're not seeing a lot of the back end kind of cancellations as the homes are completing is that I think that we've done a pretty good job of regulating or carefully managing the number of investors or speculators that have found their way into our inventory, doesn't mean we don't have any, and perhaps some markets maybe more than others, but I think that our homes under construction have remained pretty reflective of the overall cancellation rate rather than being at a larger number.

And then as a follow-up, can you talk about where you are in a community count basis versus your expectations coming into the quarter?

Do you have everything open now that you would expect it to be open at this point in the year?

I think that we feel very good about the administration of our land group, and just kind of going back to Steve's question before on the greater number of land people working within the Company, we've really gotten our hands around the land administration side.

We're not specifically reporting on community count anymore because we're not sure that's a metric that we really want to highlight as a driver of our business.

We don't think that it's consistent from quarter-to-quarter as to what open community count is.

But we will say that the difference is in line with where we expect things to be in all of the communities that we've expected to have open are open and performing well.

Thanks, guys.

Thank you.

We have a question from the line of Jim Wilson with JMP Securities.

Please go ahead.

Thanks.

Wondering can you give a little color within the regions where things are performing better or worse East, West, Central or East, West, Central and whether California weaker compared to other markets, et cetera, things of that nature?

Sure, Jim.

As we look at starting with new orders, new orders, a couple areas were highlighted if you look at our West region, new orders, Sacramento, San Diego were down year-over-year.

There was certainly an adjustment going on in those two marketplaces.

And some of these, Jim, are due to communities, and some had them can be due to actually what's happening in the marketplace.

We also had lower orders in the Tucson marketplace, and that's where I'd say on the West coast that we've had an adjustment as far as new orders go, but as you look at California as you know, Jim, we're very diversified through the state, and if you look at the other marketplaces, you know, our diversification through the states, I hate to categorize something as California or Florida or Texas anymore.

If we do look at sales incentives, if you look at the Central part of the country, we did see some more significant sales incentives in both Minnesota and Illinois during the quarter, and if we were to look out West, we did see an increase in our sales incentives in Colorado and Nevada this particular period.

So hopefully that gives you a little bit of color.

We did see improvement in some of the other marketplaces as margins improved in Florida, the Carolinas, New Jersey, we saw increases in some of those marketplace, and the other markets that I didn't mention were more of a mixed bag.

Okay.

And then the places where incentive activity is the highest you mentioned four but anything on the East coast?

On the East coast there was an increase of incentives as we've talked about on our previous, our last conference call in that Northern Virginia marketplace, and that held true this quarter as well.

But other than that, it was a little bit more consistent on the East coast.

Okay.

And then just finally, where is that activity maybe picked up more, accelerated I assume Texas or --

I'm sorry, say that again, Jim.

Where has sales activity picked up or accelerated from where it had been if anywhere?

I would assume maybe Texas has.

Sales activity was strong in Florida looking at it year-over-year.

Sales activity was strong in Texas year-over-year.

We've been growing there.

Also in the East coast as we've been expanding through the New York down through the Carolina region we've also been expanding in that area and gaining some market share, and we've had positive sales comparisons there as well.

All right.

Very good.

Thanks.

Thank you.

We have a question from the line of Carl Reichardt with Wachovia.

Please go ahead.

Good morning, guys.

How are things?

I have two questions, first on just traffic.

You'd mentioned traffic had been improving, and I'm curious about traffic conversion rates and the percentage of people actually choose to take -- choose to put a deposit down on a house.

Have those been improving as well, Stuart, as you looked at the last month or two?

Yeah, they have, Carl.

As we went through the first quarter we went from slow and sluggish to improving.

As we came to the end of the first quarter we definitely saw traffic peak up and conversion rates starting to move back into a normal zone, so the answer is yes.

Is that, that's normal seasonally, is that an improvement year-over-year, Stuart?

No, I wouldn't say that the conversion rate has improved year-over-year.

And really it's a traffic count that improves through the quarter as what we had in the first quarter and I think what we saw across the industry in the first quarter was a slower traffic count and a slower conversion rate.

I would say that the traffic count has come up.

It's still not year-over-year the same as it's been, and the conversion rate has come up, but still not quite still as we got to the end of the first quarter not as levels that we had seen in the past.

And then a second question is just on back to Steve's question about adjustments from trades and the material suppliers.

Is your focus in terms of renegotiating or pushing costs back more on the trades or more on the supplier's side?

I think it's across the board.

I think that we've all enjoyed a positive trend in the homebuilding world for a long time and we've got to be partners as the world moves around a little bit.

But really on the trade and supplier's side, we're going to have to see more moderation and volume before substantial concessions or partnering takes place there.

We're still in a competitive environment in terms of actually producing and building the homes under construction.

Okay.

Terrific.

Thanks a lot.

Thank you.

We have a question from the line of Dennis McGill with Credit Suisse.

Please go ahead.

Good morning, guys.

Just a quick one on the numbers.

Could you give us the absolute incentives as a percentage of those sales prices this quarter and last year?

Just give us an idea of the magnitude?

This year's quarter, Dennis, it was approximately 4% of the average sale price and last year's first quarter it was about 2.75%.

And, Bruce, what is the adjustment for the remainder of the year from the SG&A line back up to the management income line?

The adjustment for the entire year is approximately 50 million, and just it makes more sense as our joint venture activity has increased and management fee income, which is a good thing, is increasing and we have a line called management fee and other it seems to make sense to break it out and put it on that line.

If I could just kind of theoretically you talked about it sounds like stepping up the incentives where necessary just to keep the homebuilding production as even flow as possible.

At what point, where is the sensitivity there realizing some markets you could kind of lead yourself into offering more and more incentives just to keep the orders at a certain level?

How do we think about that?

I think the answer to that is a question of art rather than one of science.

And I think that more than just day-to-day demand plays into that.

I think that in the markets where, again, you have a healthy economy backing up healthy job growth and unemployment remains low, I think that we're inclined to kind of be patient.

I noted in my comments, Dennis, that we felt that there was a little bit of an overhang of inventory from some of the speculation that had taken place in the marketplace, some of those people putting their homes on the market that they had bought as pure investment.

It will take a little bit of time to absorb that, but I think that we want to let the market kind of work through that and not compromise our homebuilding machine.

And as to whether or not and when there might be more of a pull back in terms of our production machine will be a market-by-market question that is more artistic than scientific.

When you say in those markets where there's inventory build, you don't want to compromise the homebuilding machine, by that do you mean you will step up the incentives to keep the machine running?

I'm saying that on a case-by-case basis we have put incentives in place or other programs in place to support a consistent flow of operation.

Thanks a lot, guys.

Thank you.

We have a question from the line of Margaret Whelan with UBS.

Please go ahead.

Good morning.

It's actually Dave Goldberg on for Margaret.

My question was on the M&A markets right now and maybe relative to buying land, raw land and developing it yourself, if you could kind of talk about any changes you've seen in those kind of two ways to acquire land?

The land market has remained fairly consistent.

We haven't seen, people have asked if we've seen big reductions in land prices or things like that.

I think the general consensus within the industry is that we're seeing a softening and a step back in the marketplace that will ultimately recover.

I think for land holders, land sellers, for homebuilders, the like, I think that there's a general consensus that the fundamentals that support the business are strong and so you haven't seen a substantial step back in pricing on land.

In terms of the focus going forward, our focus still tends to be centered around land opportunities that are entitled with minimal entitlement risk, and we use an extensive due diligence process to and a pare down strategy to position our land so that it really is a very strong part of our balance sheet.

Thank you.

You bet.

Thank you.

We have a question from the line of Greg Gieber with A.G. Edwards.

Please go ahead.

Good morning, gentlemen.

I'd like to go back to, I think, Dennis' question just I need a clarification on one point.

The discount rate you're giving at 4% in the quarter, was that on closings or orders?

That was on closings, Greg.

Okay.

Is it reasonable for me to expect that, well, first of all, on those ones that were closings, were those discounts I assume were largely on standing inventory, completed inventory?

Well, it would be on both, Greg.

During the process we did have to resell some homes as the cancellation rate was a little bit higher in the quarter, so it would be on both, but you should note we have a very small number of actually completed unsold homes in the Company.

Now, it sounds to me, I mean would not discounting be somewhat higher on closings going forward if you stepped up your discounting?

I assume it will go higher, that percentage?

Not necessarily, Greg.

The market's been going through an adjustment for several months now, so it's really varied market-by-market, but looking at the mix going forward, I don't think that would make an assumption that the 4% would be higher in future quarters.

Okay.

We talk about an adjustment.

Could you actually quantify how long you think it will take to work through this?

I know it's difficult to near impossible to do it but we all have to put a number down on a piece of paper.

I was wondering if you would offer yours?

We really don't look ahead quite that way.

I don't think that we would offer an economic model that would really solve that equation.

I think that we're going to have to take market conditions as they present themselves and strategically address each market.

Okay.

If I could just ask for one last clarification on Steve's question, I thought you mentioned that you were getting renegotiations with land sellers.

Is that correct?

Yes, that's correct.

Now wouldn't that, that shouldn't really impact this year's margins all that much because I assume that that's on land you're going to use in the future rather than land you've already picked up and exercised the option or am I wrong?

Are you taking land that you already controlled and asking for a return?

Well, it is a variety of types of concessions.

Some of them have to do with the takedown timing.

Some might have to do with actual price concessions sharing in the incentive program that's out there.

But the answer is yes.

It's a combination of land that we might be buying for the future, but our focus more currently has been on option land that we have that's actually -- that we're actually building on home sites.

So you have options still to pull down on homes that you will close this year?

That's correct.

Okay.

About what percentage of your, in any given year or at this point, are still land that might be closings that are still in the options stage?

Just give me some idea how the process works?

Not only do I not have that kind of data, I'm not even sure I would know how to compile it.

Okay.

Fair point.

Thank you very much.

All right.

Thanks.

We have a question from the line of Paul Puryear with Raymond James.

Please go ahead.

Thanks.

Good morning.

We were hoping to get some more color on community count recognizing that you don't want to talk about that on a quarter-by-quarter basis.

I just wondered if you could comment on it for the year?

You're expecting to be at or above the expectation as you, when you gave your first guidance and sort of how that compares to prior year.

I think, Paul, because there has been a lot of confusion because we don't really have same store sales we've been trying to not add confusion to the mix and give community count information, but as far as us being on track with what we've laid out, as Stuart mentioned, we're very much on track.

Our communities are in place, and we've indicated in the past that if our communities count grow approximately 10% give or take a little bit, that's kind of what we need to accomplish the year, and we're right in that mix.

So communities will not be an issue for us to achieve our objectives this year.

And we eliminate as a concern with the SG&A increase the potential that the community count is up higher.

Is that not the case?

Has nothing to do with the increase in SG&A?

The SG&A is really two things.

Of the 60 basis points probably 40 basis points was due to the increase as a result of the additional land divisions that we have in place, and about 20 basis points is an increase in the broker commissions.

That's the way that would break out.

Now, as we are going to be more balanced in termed of our deliveries through the remainder of the year, or said differently, less back loaded than prior years, there should also be less variability going forward quarter-to-quarter on the SG&A percentage as that balances out you're eliminating some of the peaks and valleys.

Okay.

Thank you.

Thanks.

We have a question from the line of Michael Rehaut with JPMorgan.

Please go ahead.

Thanks.

Just first question on the improvement in traffic or some of the recovery that you had mentioned.

If you could just perhaps, if possible, give us some color on which markets you've seen that recovery occur and also if that has perhaps resulted in a little bit of improvement in the trends in terms of either pricing power or incentives?

And then I have a follow-up.

I think, Mike, pretty much across the board we've seen an improvement in traffic, and I think, you know, if you think of seasonal improvement as a percentage moving through the months of, call it, December, January, February, I would say that the percentage of improvement has been greater, but the basis is a lower starting point.

But I think pretty much across the board even in the most sluggish of markets, which I would say would include a Sacramento or San Diego or some of the other markets, I think that there's been an improvement in traffic that is meaningful.

It hasn't yet translated into a translation into pricing power.

I think that as we came to the end of the first quarter we didn't see great improvement in pricing power, but I think it left us in our minds with cause to be optimistic as we look ahead.

Just going back to the land sale gains for a moment and the increased investment there, the higher guidance of 270 million in profits and a lot of that it appears is kind of being offset by the higher SG&A percentage for this year, but I was wondering if you could just comment how you see yourselves as a company?

Obviously, this is part of a longer trend that you've increased your efforts and resources here, and where do you see things normalizing in terms of the actual homebuilding operations versus the land development and sale operations, perhaps even if you could venture a guess in terms of a percent of EBIT one versus the other, or how do you see the mix of your business progressing over the next couple of years between these two different areas?

Well, as you might expect I won't reduce it to a percentage of EBIT.

I think there's going to be some movement in those numbers, but I would say that it would be important for people to remember that we place a great value on the land component of our business.

We bring a lot to the table in that regard, and we use that land expertise as an opportunity to fuel a strong and focused organic homebuilding machine that is continuing to grow and grow in a very methodical way, and we bolster our fueling of our own land position with a desire to use that land expertise to sometimes buy larger parcels and to use a pare down strategy to balance our program to keep our balance sheet well pruned and well positioned.

So we expect that as our Company grows, as our homebuilding machine grows, so too our land program will continue to grow using that franchise and that expertise to not only fuel our position but also to be able to profit by being strategic and providing needed ground for others as well.

So the growth in our bottom line relative to land profit is a strategic growth.

The growth in the asset base on the land side is strategic growth as well.

They are a factor of each other.

As we grow the land side of our business, the pruning process, the pare down, strategy is likely to continue to generate profit which is a strong indication that we are, as we've said, good land buyers, unusually good land buyers, so we expect that both sides of the business will grow.

The actual proportion will vary a little bit from time to time, but we're very focused on an organic growth strategy for homebuilding and a strong franchise based land program to support it.

Right.

I guess just to make sure I understand here, about several years ago land sale gains as a percent of EBIT was more like 5%.

Now it's closer to 10%, and again, while you said you didn't want to boil it down to just one number, can you at least give us an idea if that trend is going to continue in that direction?

Well, as I said, I'm not going to venture to try to separate out where and how in the future it will actually grow.

I would just leave you with the thought that as our homebuilding operations continue to grow, we're very enthusiastic to see that our land profit as well continues to grow.

We just feel that we not only provide a great service within the homebuilding industry, but we do it particularly well in the growth in that land sale side of the business is, you know, it's as organic to the homebuilding industry and the homebuilding machine as anything.

It's all part of the same process.

So I would expect that our land number will continue to grow.

But the actual proportion will move around a little bit.

Okay.

And finally, just one small detail on the guidance, Bruce.

You mentioned that you had about looking at 495 in land sale gains, equity earnings and management fees, and you broke out the land sale gains of 270, but I was wondering if you could just give us an idea how the rest falls out between equity earnings and management fees and also if you're still looking for about a 330 ASP for the year on the closings?

Yes, we haven't changed the ASP, Mike, and as far as the joint ventures, we weren't changing the joint venture number this quarter.

So it's in that 150 to 160 range, and then the remainder is management fees, about 65 to 70 million.

Thanks a lot.

You're welcome.

Thank you.

We have a question from the line of Myron Kaplan with Kaplan Nathan.

Please go ahead.

Hi, guys.

Hi.

Very good quarter.

Most of my questions were answered.

I would just ask the prevailing opinion in the analytic community is things are going to continue to get worse before they, or if they ever get better at some time in the future, and I guess some of your feedback is that it's better or that it's not getting worse anymore.

Well, I think that what I've said is that the indication as we came to the end of the quarter was that the trend was getting better, and it could make some additional shifts as we look ahead to the downside or to the upside.

But just like the bubble theorists have maintained their bubble theory for the past six or seven years and they think that someday they'll be right.

I, too, would probably maintain a philosophy that the homebuilding business will get better.

I think that our trend, if we look at against a ten-year kind of population expectation curve, and if we listen to the demographers, it really looks like the next ten years in homebuilding ultimately have to be very, very strong years, similar to what we've seen over the past ten years, and while there might be shifts and jogs along the way due to economic factors and other things, people still need a place to live, and we think that the prospects of the homebuilding industry ultimately become good.

Right.

Thanks.

The question also is how much -- what's the cost of the expense to stock options for '06, please?

For '06 it's about roughly $0.10, Myron.

So that', again, apples and oranges compared to '05.

Correct.

It was zero in '05.

Right.

Okay.

Well, thank you, guys.

Well done.

I think we'll come to our last question, please.

Thank you.

That last question comes from the line of Stephen East with SIG.

Please go ahead.

Good morning, guys.

Just a couple of housekeeping questions.

Bruce, when you acquire a backlog, how does that come in from a profit perspective on the accounting?

When you mark-to-market, does that eliminate all profitability on those?

What we do, Steven is use purchase accounting and over the first, the closings over the first quarter are reduced significantly from a profit standpoint if there's construction in place, so what closes the first quarter is very nominal and then it increases a little bit in the second month and the third month, and then starting in the fourth month it's a normalized profit recognition.

But basically, the answer to your question is acquired backlog generally has zero impact on earnings.

Very, very small if any.

It dilutes margins the first quarter.

Okay.

That's what I was getting at.

And then just the other question on your conversion rates, on the West it was pretty low year-over-year.

Maybe what was going on and what we should expect from the West region moving forward this year.

Well, I haven't broken out the West region in front of me from a conversion standpoint.

But overall, Steven, you are going to see an increase in our backlog conversion ratio in Q2, 3 and 4 compared to the prior year as our homebuilding plant is running very efficiently, so overall it's increasing.

I haven't gone through each individual market in front of me as far as a conversion factor goes, but we're seeing improvements really across the board from a conversion standpoint.

Okay.

Thanks.

Thank you.

We would like to express our appreciation to all of those still with us for joining us for our first quarter update, and we look forward to reporting back as we come to the second quarter and beyond.

Thank you.

Thank you.

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