Lennar Corp (LEN) 2008 Q2 法說會逐字稿

Thank you for standing by, and welcome to Lennar's second quarter earnings conference call.

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

After the presentation, we will conduct a question-and-answer session.

Today's conference call is being recorded.

If you have any objections, please disconnect.

I will now turn the call over to Mr.

Scott Shipley, Director of Investor Relations for the reading of the forward-looking statement.

Good morning, and welcome to Lennar's second quarter earnings conference call.

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

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

Forward-looking statements represent only Lennar's estimates on the day 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 Lennar's 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' contained in Lennar's Annual Report on Form 10-K, for it's most recently completed fiscal year, which is on file with the SEC.

Please note that Lennar assumes no obligation to update any forward-looking statements.

I would like to introduce your speaker for today's conference, Mr.

Stuart Miller, President and CEO.

Mr.

Miller, you may begin.

Thank you, and good morning everyone.

Thank you for joining us for our second quarter 2008 update.

I am joined this morning by Bruce Gross, our Chief Financial Officer, Diane Bessette, our Vice President and Treasurer, and David Collins, our Controller.

Bruce is going to give some additional detail on our numbers, as is traditional, and David is going to give you an update on our asset review and impairments, a report that we have now given for over two years.

Diane of course will be available to participate in our Q&A.

Just as a housekeeping item before I start, I would like to request that in our question-and-answer period that will follow our opening remarks, that you please limit to just one question and one follow-up, so that we can be as fair as possible to all of our participants.

We of course welcome you to rejoin the queue if you have additional questions, and we will attempt to answer as many as possible in the hour more or less, that we have allotted for the call.

So let me begin.

The housing market has continued to deteriorate throughout the first half of 2008, and as I noted in our press release this morning, we expect that this trend is going to continue for at least the remainder of the year.

The deterioration that unfolded so quickly in the housing market over the past years has now spread to the overall economy.

And while there are some who still suggest that we might avoid a recession, and believe the economy will continue to grow though at a slower pace, their case is becoming more and more difficult to make, in the face of rising unemployment data, report low consumer confidence figures, and a credit crisis that is constraining the movement of capital.

And even as the Fed spoke yesterday, and noted that the threat to growth had eased, that is until the stimulus checks are spent, it is apparent that inflation looms as a driver of potentially higher interest rates, if not sooner than probably later.

This is the simple reality of the market in which we are operating, and these conditions are likely to persist for some time.

I am asked regularly as to whether or not we are at the bottom.

And I feel overall that we are not there yet.

A little over a week ago our senior management team visited with each of our divisions over a two week period as we did our ops review.

We reviewed each of our divisions in detail, and evaluated the dynamics of each market in which they operate.

Generally speaking, there are not yet signs of stabilization in the field.

Demand patterns are inconsistent and erratic, and we found that there is a constant flow, an increasing flow of foreclosures, that are maintaining downward pressure on prices and appraisals.

And in many markets, it is apparent that the flow of foreclosed homes is expanding rather than subsiding.

There is a silver lining in all of this, though it is currently of limited consequence.

The positive news from the field relative to some markets, is that inventory of finished homes is coming down, the number of open competing new home communities is declining, and the number of builders is also declining.

In spite of this rather sobering market information, the rather sobering market information that we learned in our ops review, we also learned that we are making a great deal of progress in adjusting our business to not just survive, but to succeed in this difficult environment.

We are focused on a quarterly progression of positive trends in this down market environment.

I would like to walk through some of the elements that will contribute to these trends, that we saw as we visited each of our divisions.

First and foremost, every one of our divisions has made the transition from being primarily focused on asset management, to being primarily focused on their manufacturing business.

Assets have been sold or written down, joint ventures have been restructured or dissolved.

In fact, we have reduced the number of joint ventures from 270 at the peak, to about 163 currently.

Our overall land asset is down similarly.

Additionally, each division brought tremendous focus on inventory homes in the second quarter, and reduced completed inventory by almost 50% sequentially.

Great progress has been made on the asset side of the business, so management can focus on sales, construction, and inventory.

Our divisions of back to the basics, of blocking and tackling pure home building.

We have gone back to the basics on product.

In our reviews we fon that every division has reworked it's product for the current market environment, and that means simple product, fewer planned, and a fresh look at scaling back included features.

Each division has positioned product to offer excellent value, and to be able to compete head to head with our toughest competitor, foreclosure sales.

Square footages are generally smaller, and product design is simpler.

This competition is based on pure value.

We reviewed sales and marketing efforts.

On the sales front, we are using the internet sales machine more effectively and extensively than ever.

Division presidents are personally immersing themselves in our internet sales program, and driving up the learning curve.

Currently, each division is treating the internet sales team more like a general Realtor, with the ability to cross-sell across Lennar product offerings in the market.

By doing this we have increased our internet sales result by more than triple.

On the marketing front, Kay Howard has initiated a series of corporately generated and coordinated sales events, that have gotten our divisions to engage in a friendly competition within the Company.

We have found that every division has been thoroughly engaged in these programs, and enhanced their sales performance with participation.

Focus was brought through these programs to manage a lower cancellation rate, and this contributed to a cancellation rate that has been at more than a three year low of some 22%.

With simpler products, we have seen tremendous results in reducing construction costs.

With the leadership of Mike Foster in Tampa, we have revamped our purchasing effort, to benefit from regional and national efficiencies, as we have moved across all divisions, to disassemble labor and material contracts, and begun purchasing on a unit basis for labor and materials separately.

We are seeing costs come down by as much as 20%, some of which is flowing through our numbers today, and some will be coming over the next quarters.

And because our standing inventory levels are extremely low and current, less than one home per community, new home construction costs are defining the cost structure of most of our deliveries, especially as we get into the third and fourth quarters.

Our divisions are using purchasing practices and product simplicity to become the low cost producers in their market.

On the SG&A front, SG&A will be at 10% of revenues or lower in each division by year end.

This is our focus and our directive, and there are no excuses.

We found that many of our divisions are already there or below.

Now practically speaking, a few might not make it, but overhead is coming down quickly, and every division was impressive in displaying their attention to this metric.

So with construction costs coming down, and overhead reduced, product repositioned, and land costs at proper levels, where are margins going?

Our net home building margin is beginning to improve, with a positive net margin of 0.5% excluding valuation adjustments.

While this margin is decidedly weak, we expect that we will continue to see improvement in margins that begin to market trend.

Of course the wild card is going to be sales pace and sales price, and right now we are in what I call a price taker business with no pricing power.

With market conditions as they are, we recognize that some things are just out of our control, and we are simply not going to be able to control those elements, but the items that are in our control, we are all over them in each of our divisions.

On the corporate side, we have complimented the progress in the field.

Our balance sheet remains strong with a substantial cash position of $880 million plus.

While this is down some $200 million from the first quarter, we are decidedly using cash, to seize opportunity where distress creates unique value, rather than walk away from that opportunity.

We anticipate that we will continue to use another 200 or $300 million of cash over the next quarters for additional opportunities as they arise.

We are building our business for the future.

Additionally, there is nothing borrowed on our revolver, and we have a responsible debt to total cap position at 39.5% net of cash that is under 30%.

In the wake of the meaningful restatements of assets that we have undergone, and the repositioning of many of our joint venture properties, this is meaningful progress.

And while we continue to lose money in our first quarter, with the loss per share of $0.76, and a homebuilding operating loss of approximately $140 million, aggregate levels of impairments and losses are more in the nature of clean up, rather than reconciliation to unknown market conditions.

We have done the heavy lifting on impairments, and are now situated with stated assets that can, and will produce improving margins, when the rate of decline in market pricing subsides.

We are very confident that even with continued degradation of market conditions, our stated asset base will not suffer nearly the levels of impairments that we saw in 2007.

We have reworked or are close to a rework on most of our nonperforming joint ventures, and the trend on joint ventures is positive.

As I noted earlier, the number of joint ventures has come down materially, and Bruce will give some additional color on some of the financial metrics.

While we will not and cannot comment on specific ventures, we have held true to our conviction, that we do not support the debt of nonrecourse obligations, and we are not excusing partners from sharing partnership losses.

While the negotiation process can be difficult and time consuming, many of our partnerships have presented us with an opportunity to actually enhance our investment position.

Let me briefly comment on the land source joint venture that many have asked about.

As the press has reported, that venture has now gone into bankruptcy, and the judge will consider a plan of reorganization.

In as much of this is ongoing, I will not comment specifically on the case.

But as it relates to Lennar, one should recall that the $1.2 billion of debt is non-recourse, and that Lennar's investment on our books is zero.

So as large as this asset might seem, the potential impact to the Company is not material.

In conclusion, let me say that we have made a great deal of progress in this very difficult market.

We have prepared our companies for market conditions as they currently exist, and we are not projecting a material improvement for some time to come.

This should not be confused with abject pessimism.

In fact I remain quite optimistic about our business, and about the housing market in general.

This market will rebound.

It will have to rebound in order to stimulate the rest of the economy back onto it's feet.

Whether over the next month, or after the election, steps will be taken out of necessity, to facilitate home ownership's leadership out of the economic doldrums.

The indicators keep coming, and while there is discussion and disagreement back and forth on what they mean and how to fix things, it seems that we are quickly approaching the time where decision makers will reconcile to the reality, that positive constructive steps need to be taken, to properly support weakened markets and enable them to recover.

We believe that an integral part of the answer that will emerge, is that fixing the component of the economy that has led us into economic contraction, i.e.

homebuilding, will be the first and most important step in leading us out.

In this fix is the bright light that I see at the end of homebuilding's dark tunnel.

As I noted already, the home market is faced with increased supply and suppressed demand, home inventories, primarily existing homes, are expanding, and will have to be absorbed before pressure is relieved, from sales volume and from price.

At Lennar, we have been heads-up throughout the downturn in the housing market, and we have prepared our Company to succeed in the current market conditions, and to thrive when the market ultimately corrects.

With that, let me turn it over to Bruce.

Thank you, Stuart, and good morning.

I will be providing some of the financial details supporting the significant progress that Stuart just outlined with our balance sheet strategy, our JV recourse step reduction, and our return to positive operating margins.

Starting with the results of our balance sheet strategy, we remained focused on aggressive asset management, and maintaining ample liquidity.

We have continued to carefully manage our inventory levels, as they have been reduced by 47%, from $7.3 billion in the prior year's second quarter, to $3.8 billion during the current quarter, excluding consolidated inventory not owned.

The finished homes and construction in progress inventory was reduced 39%, from 3.6 billion to 2.2 billion year-over-year, and land under development was also reduced 56%, from 3.7 billion to 1.6 billion.

This quarter we continued to cleanse our balance sheet, as we aggressively reduced our unsold completed homes by 70%, from 1,441 in the prior year to 428 in the second quarter, and sequentially it was also down 47% from the first quarter of 2008.

We have continued to manage starts to today's demand levels, and as a result homes under construction declined 42%, from 11,200 in the second quarter of last year, to about 6,500 in the second quarter of 2008.

Our home sites owned and controlled were reduced by 61% since the peak in 2006, from approximately 346,000 to 134,000 home sites in the current quarter.

That breakdown is 73,000 home sites owned, 15,000 controlled by option with third party land sellers, and 46,000 optioned from joint ventures.

Land purchases during the quarter were 162 million, that is a 72% decline from the prior year.

Any land purchases that we are making are very strategic.

They are priced to generate high returns, taking current market conditions into account, and they are structured to protect us, if there are further declines in the marketplace.

Our continued balance sheet focus continues to position us with excellent liquidity.

In the second quarter we returned to a positive EBIT margin, before valuation adjustments of about $2 million.

As Stuart mentioned, our liquidity position was strong, with 882 million of homebuilding cash on the balance sheet, and additionally, there were no outstanding borrowings under our revolving credit facility.

Inclusive of impairments, our net homebuilding debt to total capital improved to 28.7% this quarter, from 29.6% in the second quarter of last year.

And our homebuilding debt to total capital was 39.5%, versus 31.6% in the prior year's quarter.

Our debt level is down 275 million since the prior year's second quarter.

There has been significant progress made in both the reduction in the number of joint ventures, as well as the reduction of joint venture recourse.

The Company has focused aggressively on reducing the number of JVs, which was at a peak of approximately 270 JVs in 2006, and now there are 163 joint ventures as of the end of the second quarter.

Of these joint ventures however, only 57 have recourse debt.

31 have non-recourse debt, and 75 have no debt.

Our primary focus has been to reduce the joint ventures with recourse debt, which is already down from approximately 100 in 2006, to the 57 remaining joint ventures with recourse debt at the end of this quarter.

The maximum recourse JV indebtedness was approximately 1.8 billion at the end of fiscal 2006.

That has been reduced aggressively by about $1 billion, and we ended the quarter with 807 million of recourse indebtedness in joint ventures.

Sequentially, this was also reduced significantly from 917 in the first quarter.

Lennar's net recourse JV exposure was also reduced to 613 million at the end of the quarter.

There has been a lot of attention directed to our joint ventures, and I would like to emphasize that in addition to very significant reduction in JV recourse indebtedness, these joint ventures were conservatively financed at the time that the debt was put in place, and these JVs with net recourse debt exposure to Lennar, have a total of $1.2 billion of partners equity in place at the end of this quarter.

We are confident that we will continue to significantly reduce the JV recourse debt exposure in each of the next several quarters.

There was also significant progress in the reduction of financial letters of credit, which were cut by more than half, from the 728 million outstanding at the end of 2006, to 337 million at the end of this quarter.

Turning to the operating results for the quarter, we had a $0.16 loss for the quarter, which excludes 137 million of pretax valuation adjustments, which David will walk through in a few minutes.

Revenues on home sales decreased 62% to approximately $1 billion.

That was driven by a 58% decrease in home deliveries, and an 8% decrease in average sales price to $274,000.

The average sales price is net of sales incentives, which averaged 48,700 per home during the quarter, which increased about 5,000 per home compared to the prior year.

The average sales price by region is as follows.

In the East, it is 254,000 which was down 11% from the prior year.

Central, 210,000 which was up 1%, the West was 364,000 which was down 16%, and the Other region was 302,000, which was down 5%.

In this quarter, the second quarter of 2008, we achieved the first positive operating margin since the first quarter of 2007.

Our gross margin was 15.9% before valuation adjustments, and selling, general and administrative expenses were 15.4%, resulting in a 50 basis point positive operating margin.

The pre-impairment gross margin improved 230 basis points over the prior year, and the improvement in gross margin is primarily due to a lower land basis, but additionally, as Stuart mentioned, our focus on repositioning and redesigning our product to meet market demand, while continuing to aggressively focus on reducing construction costs in all areas of the Company.

The East segment of the Company experienced the largest improvement in margin during the quarter.

We have acted aggressively to right-size our SG&A during the downturn, and we have made significant progress on reducing the variable component of SG&A, and now we are beginning to see the results of our progress on the fixed component of SG&A.

We are at the back end of division consolidations and head count reductions, as our associate head count has been reduced from the peak in 2006 by approximately 60% through today.

SG&A was reduced by 239 million during the quarter, which is a 60% reduction to the second quarter of last year.

As a percentage of revenue, SG&A was up 70 basis points compared to last year's second quarter, but sequentially from the first quarter of this year, it was down 300 basis points.

The progress that has already been completed and the actions taken, give us the confidence to say that our divisions are on-track to achieve the future annualized SG&A run rate of 10% by the end of our fiscal year.

New orders were down 45% during the quarter compared to the prior year.

The number of homes in backlog declined 52% year-over-year.

And in this quarter we delivered over 100% of our backlog, our backlog conversion ratio this quarter was 113%.

We had a 22% cancellation rate that compared to 29% in the prior year's quarter.

Our financial services profits decreased from a $14.2 million profit, to a loss of $3 million.

Mortgage increased from 4.6 million of profit last year, to 8.1 in the current year, and that was primarily due to the prior year having a $14.4 million land note receivable write-down.

This quarter our mortgage capture rate improved from 72%, to 85% year-over-year.

And almost all of our loans in this quarter were fixed rate conforming loans.

The percentage of Government loans increased to approximately 60% in this quarter, and that is up from 19% in the prior year.

This is the first quarter that the higher FHA mortgage loan limits went into effect.

Our title company experienced a $10.7 million loss.

That compares to an 8.1 million profit in the prior year.

And this was a result of fewer transactions, as well as 6.7 million of nonrecurring expenses, primarily related to severance and lease termination costs, as we focused on right-sizing our operations to current market conditions.

As we indicated on the first quarter conference call, our tax rate will fluctuate through the year based on results.

This quarter we adjusted our tax rate to a 36% year-to-date tax rate.

Some of you have called last night or this morning asking about the shelf registration filing yesterday.

This is a routine filing to reinstate our shelf that was in place for several years, and expired last week.

With that, I would like to say that we have made significant progress again this quarter, and we look forward to discussing additional progress again next quarter.

With that, I would like to turn it over to David.

Thank you, Bruce, and good morning everyone.

As is tradition during our conference calls, we are once again providing an update of our impairment process to provide further clarity.

In this morning's release, we outlined our second quarter valuation adjustments of $137 million.

We continue to remain actively engaged in our rigorous process of division by division asset reviews, to insure that our assets are property stated.

We started this impairment process about two years ago, and were diligently early on in reviewing our asset base and recording impairments.

As we have previously disclosed, we believe that most of the heavy lifting regarding impairments is behind us, and that we are at the tail end of the impairment cycle.

Let me quickly summarize our second quarter impairments.

First on the homebuilding side of our business, we once again applied the standards of FAS 144, to land that we intend to build homes on, and recorded a valuation adjustment of $74 million.

This segment detail is as follows.

East 34 million, Central 17 million, West 20 million, and Other 2 million.

The second bucket is land that we sold or intend to sell to third parties.

Consistent with our strategy of converting inventory into cash, we identified land that we sold during the second quarter or intend to sell subsequent to the second quarter.

We applied the standards of FAS 144 to that land, and recorded a valuation adjustment of $2 million.

The segment detail is as follows, East had $1 million,, and the West had $1 million.

The third bucket relates to land option deposits and preacquisition costs.

We continue to evaluate, re-evaluate, and renegotiate, deposits on land under option, as markets remain challenged.

For those option contracts that we were not able to adjust or readjust the terms, to a level that we believe would lead to an acceptable return based on current market conditions, we made the decision to walk away from the contract, as we have done in past quarters.

As a result, we wrote off $7 million of option deposits and preacquisition costs, which represented approximately 2,100 home sites.

The segment detail is as follows.

East $3 million, Central $1 million, West $1 million, and Other $2 million.

The fourth and last bucket is our joint ventures.

As we do with all of our assets, we continue to evaluate and re-evaluate our investments in joint ventures.

During this impairment cycle, we have recorded cumulative adjustments to our investment in JVs of $726 million, in our review we focused on the recoverability of our investment, relative to the market conditions that exist today.

We applied the standards of FAS 144 to the assets in our joint ventures, including the evaluation of discounted future cash flows.

Additionally, we applied the standards of AVB 18 to our investment balance related to those joint ventures.

In the second quarter, we recorded a valuation adjustment of $55 million.

The segment detail is as follows, East $12 million, West $43 million.

So after that overview, we would like to open it up for questions.

(OPERATOR INSTRUCTIONS).

We have a question from Dennis McGill, Zelman & Associates.

Morning, guys.

Thank you for the update.

Bruce, I think we heard you correctly, but on the FHA side, did you say that was 60% of the volume?

That is correct, the Government loans were 60% of the mortgage loans that our mortgage company originated, which was 85% capture rate.

Okay.

So that would be on closings then?

That is correct.

Okay.

And I guess can you just elaborate on that a little bit?

I think there might have been some promotions related to that in the quarter, but is that abnormally high?

Would you think that goes higher in the coming quarters, based on what you are seeing in backlog?

Yes, I think what we have been seeing for a couple of quarters, now there has been an increase in the FHA loans, and the FHA loans which require a much smaller down payment are the attractive financing source that is available out there today, and we do believe that the higher FHA percentage is likely to continue at this point.

And then just because it has been in the news flow, related to the down payment assistance, is that something you guys participant in in any meaningful volume?

We have had down payment assistance for several years now, and there are a percentage of our buyers that do use the down payment assistance.

It was about one-third of the loans that we originated during the quarter, but again I think one of the things to highlight, is that the difference between down payment assistance and FHA is about $6,000 of down payment on our typically priced home.

Okay.

And kind of switching gears, and maybe this is best suited for you Stuart, but just thinking of your top level view, and how the shrinking of capital from banks, for both residential and I guess even commercial lending is taking place, what your view is over the next year, as I guess more, more land comes to market via foreclosure similar to what has happened on the house side, and what that might mean for land values going down, and potentially opportunities for well capitalized builders?

Well, I am not sure I fully got the question.

But I think what you are asking is, with available capital somewhat constrained, are there going to be dollars available for people to buy homes, and the answer is I think that there will be dollars for people to buy homes.

It will be primarily through either FHA programs or GFB programs, Fannie Mae--.

Sorry for mixing kind of the two themes up, but I was referring more to on the lending side to builders and developers themselves, and builders that are struggling with the capital structure and not able to perform on their loans, and forcing some of that back through the market, on the repossession side.

Builders that do have capital, how do you see that playing out?

I think that exists right now today.

I think that that constraint is out there, and it is creating what I referred to in my comments as some of the distress that is in the market.

We are seeing it probably first in the joint venture arena.

And it is creating opportunities even today at today's depressed pricing and sales pace levels.

And it is those kinds of opportunities that we think are going to mark the future for the industry for the well capitalized builder.

There will be those opportunities to rebuild their business around.

These opportunities aren't out in the market right now.

They haven't surfaced yet.

But they are coming.

And I think that as market conditions continue to weaken over the next year, and especially the credit side of the business gets more difficult, there will be opportunities to start making purchases where healthy margins can be garnered.

And so thus far you haven't been active in any type of bank owned properties yet?

We have been very active, but Dennis, we have to move on to the next person.

That is fine.

Thank you.

Thank you.

Our next question is coming from Carl Reichardt, Wachovia Securities.

Morning, guys how are you?

Good morning, Carl.

I had a question the specs now at less than 1 per community, is that a relatively concentrated regionally, or is that more average across the board, and what was a rough lift fall in communities year-over-year this quarter versus last?

Let me first address the spec inventory level.

There has been a focused effort in every division in the Company and every community, to reduce the level of spec homes.

So we have seen that success throughout the Company.

It is not concentrated in any one particular geography.

And in terms of the community level, Carl, the community count isn't a number that we have given out for the quarter.

Yes, Bruce is fumbling, because we just don't give out community count as you know Carl, but the fact is that our community count is down materially.

In terms of the spec level, no, there is not concentration, in fact what was really a very positive message, take away from the quarterly ops reviews was the fact that each division had really focused in on spec levels.

In every single one of our divisions spec levels were down materially.

Go ahead.

No, that was it.

Okay.

Then just the one follow-up to that, is then in looking at backlog conversion being triple digits, do you sense that you are through this process enough, given that under the assumption that we don't see a significant negative change in absorption pace, as we look at backlog conversion the next several quarters, we ought to see that come down relatively materially, as you start to replenish the backlog, or replenish the backlogs?

Is that the way to think about it?

Over the next quarter you will still see a very high backlog turnover conversion ratio, Carl.

Our focus is to make sure that the inventory levels are being managed tightly, and we are not ending up with completed homes at the end of the day.

But I think you will see that conversion ratio stay at a high level over the next couple of quarters.

That is reflective Carl of both construction timeframes coming down, and keeping our sales and construction pace very, very tightly tied together.

So I would expect that it stays, it stays where it is.

Okay.

I appreciate that.

Thanks so much, guys.

Sure.

And our next question is coming from David Goldberg, UBS.

Thanks, good morning guys.

Morning, David.

My first question is kind of a little bit theoretical,l but you talked about taking the business from focusing more on the regions on asset management to home building now, and more on to efficiency.

I guess what I am trying to figure out is how does that impact the business over the long term, when things eventually do normalize, do you think you transition to be kind of somewhere in the middle?

And how easy is it to bring back specialty, or that ability back on?

As you know, David at the highest level in the Company, we have maintained our management team intact, and we think that that is where the real franchise on the asset management side of the business is.

What we have really done, and we are really pretty excited about this, is at the division level we have our divisions focused on being real manufacturers.

So as the market returns, I think that we are going to be at the forefront of being able to uncover some of the most sizable and interesting opportunities, because our top level management team is really expert at that.

But in the field, we are focused on sales starts, closings, inventory levels, and asset-based, making sure that our divisions are really focused on becoming a pure manufacturing machine.

Now one of the questions that was asked earlier by Dennis, was are you participating in some of the bank deals that are out there.

That is one unique thing that does exist here at Lennar, is the fact that we are looking at just about every deal that is hitting the market.

As you know, Jeff Krasnoff is back with the business.

Jeff and I have a long history looking at those portfolios, likewise John and Rick and Neil, and so I think that there is an important balance, between the manufacturing focus in the field and what the corporate office can bring to bear on more sizable and more interesting deals, that are a lot more opportunistic.

That is a great answer.

Thank you.

I guess the second question talks to the impairments, and how you guys get comfortable that the last couple of quarters has mostly been clean up on impairments, but if you expect continued deterioration in the operating environment, certainly the order base is slowing down, pricing is coming down, and incentives are possibly going up, how do you get comfortable that you are not going to see more impairments or sizable impairments as you move forward.

And maybe as a corollary to that, is it correct to assume that the reason there haven't been more impairments is because you have done a great job on the cost side of the business, and that has offset some of the other inputs that have been more negative?

Okay.

Well, there are a few things that combine in that.

Number one, let's remember that our asset base itself has shrunk materially.

So the amount of impairments that can possibly be out there is materially shrink.

Number two, when we did our impairment analysis as we went through the past year, we have anticipated that the market would not be improving, but instead would continue to decline.

So the market conditions that I described in my opening comments are market conditions that we have anticipated, we have not had our head in the sand on this.

To the contrary action, we have written our assets to a place where we are comfortable that those assets, that the statement of the assets will be properly positioned for the future, even as the market continues to deteriorate.

Another element is the fact that we have brought down our pricing in the field quite a lot, probably more than the existing home market has.

I think that there is less correction ahead for the new home market, than there is for the existing home market.

Then the final point is, you are absolutely right, David, that our cost structure is changing.

We are bringing down construction costs at a very impressive rate.

What I saw in the field was some of the initiatives, that a gentlemen named Mike Foster is really spear heading across the Company for us, is that both at the local, regional, and corporate level, we are finding ways through unit cost pricing, to bring down construction costs at an accelerated rate, even where you have commodity prices going up.

This is very important in the underwriting of future impairment.

We think we are going to be able to be profitable in almost every one of our land positions going forward, even in a declining market.

Okay.

Great.

Thanks so much.

Sure.

And our next question is coming from Michael Rehaut, JPMorgan.

Hi, thanks, good morning.

Good morning.

First question, if you could just give us a little bit more detail on JVs, and it was good to see that the recourse debt continues to come down.

I was wondering if you could, Bruce or Stuart, just describe how much cash out went this quarter for JVs, for debt pay down or unwinds, and where your total balance sheet investment stands?

Sure.

Let me talk to the point of how much went out to joint ventures.

The total contributions during the quarter to joint ventures were between 50 and 60 million, and a smaller portion of that went to remargining, relating to joint venture debt.

As far as the joint venture investment balance for the quarter, that number is approximately 870 million at the end of May.

Okay.

And so the 50 to 60 million includes any type of debt pay down as well, as the recourse debt came down?

That is correct.

And any contributions to joint ventures are in that line.

The remargins amount is a subset of that 50 to 60 million.

Okay.

Before I just move on to the second question, a small subset question on JVs if I could, just any update on Kyle Canyon or Heritage, or where your exposure stands for those two ventures?

There is no update relative to Kyle.

We don't have any investment in Kyle, and there is no update there.

Heritage, we still feel very good about it.

It is a very strategic joint venture for us, that is El Torro, and we are still going forward as we have talked about in the past.

Okay.

Second question just on land investment, we have I found that pretty interesting that you spent 162, I was wondering if you could kind of break down how much of that was option take downs, and how much of that, as you were saying, more opportunistic purchases, and if you could give any color, in terms of where those were, and you also mentioned that they were structured to protect Lennar from future declines.

I was wondering if you could go into a little more detail there?

Mike.

We are very clever here.

We know that you have now asked three questions, and that that third question had six parts to it.

So.

Well, if you could just answer a part of it, I would appreciate it.

We see you, but Mike, I think what I would have to say is that every dollar that we spend right now is opportunistic.

All of the dollars out, if we are not, if we are not in an option deal, finding that we are buying into a good opportunity, we are walking, and we have done that aggressively.

So when you look at the dollars that we are spending on land, and you are asking, how much of that is opportunistic versus options.

Each of our option deals have either been reworked, or they have been walked from.

And they have been reworked to a point where we feel that we have a good and solid opportunity.

We are not land banking take downs, and supporting deals and ventures, and stuff like that.

Each deal that we are taking down today is opportunistic.

So I would have to say all of it.

Okay.

Thank you.

You are welcome.

And our next question is coming from Tim Jones, Wasserman & Associates.

Hello, guys.

Good morning, Tim.

Let's go back to Homebuilding 101, gross margins and SG&A.

First of all on the gross margins, 230, I mean it is a remarkable improvement that you had.

You said part of it was to a lower land base.

How much of that was coming through a reversal of previously impaired projects, and how much was related to your cost savings, and materials and labor?

Well, you know something, Tim.

We knew that question was going to be asked, and we suspected it would be asked by you.

(laughter)

We spent a lot of time thinking about the answer to that question, and given the size of the impairments that we have taken, it is really hard to delineate that in a meaningful way, because when I come down to that evaluation, I would almost have to say that all of it is attributable to land write-downs, because so much of our land write-downs have, it affects every community that we are in.

And so, or unless we are taking down option home sites.

So, it is hard to, it is not only hard, it is impossible to really delineate where the margin improvement is coming from.

What we can tell you is that what we have done is across the board rewritten our land to a point where we can produce margins, and as we go forward, margin improvement will continue to come from cost reductions, construction cost reductions, and from SG&A reductions.

Now back to Homebuilding 101, on the construction cost side as I said earlier, we are seeing construction costs that are coming down as much as 20%.

Now that doesn't mean 20% across the board, but in many instances, we are seeing that kind of improvement.

If we look back over the past year, and we look year-over-year, we are probably seeing something short of somewhere in the 7 or 8% range, in terms of construction cost reduction.

But as we look ahead, we see more and more cost savings coming through.

Now the land price is remaining fairly stable going forward, and finally on the SG&A level, we are looking at an SG&A level that is really coming down from somewhere in the 14 to 18% range.

Hello.

Who is barking there?

That is Barkley.

Anyways.

I always feel.

The question though on the second question, which is did you say I couldn't believe my ears, that you expected the SG&A rate as a percent of sales to be 10% in the fourth quarter?

At the division level, we are expecting every division to be at that level by the fourth quarter.

Now as I said, realistically and practically speaking there are going to go be some divisions that don't quite get there, but the amount of progress that has been made in that direction is striking.

And a number of our divisions have already gotten there.

And every one of them has a plan to get there by the fourth quarter.

So the answer is yes.

When is the last time in the Company's history that you had that?

These are different times and.

I would say, can't remember.

I don't remember, but I will say that that is, that is our focus today.

Each of the components of the manufacturing business starting with SG&A is absolutely where we are focused.

Okay.

Thank you.

I was going to ask one more, but you are getting short.

Thank you.

Okay.

Get back in the queue.

I will.

I won't have a chance, but I will.

Our next question is coming from Jim Wilson, JMP Securities.

Good morning, Jim.

Jim, are you there?

Next.

Jim, your line is open, you may want to unmute your phone.

We will go on to our next question.

Steven East of Pali Capital has the next question.

Good morning.

Morning.

If we, if you can talk a little bit, you talked some about the unique opportunities, that you were using your cash for.

Are those primarily attractive JVs that you would prefer to consolidate, or would these be purely independent deals that you are seeing coming down the pipeline?

Primarily right now, JVs and that is because that is where we are seeing, that is where we are seeing distress turn into current opportunity.

In the market at large we haven't seen that much actually come through the pipeline.

I noted before, Steve, that we are underwriting a number of deals and portfolios that are out there.

Frankly the reality of market conditions has not yet really filtered through to the sellers.

So I kind of look at these as what I call warm-up exercises.

What we saw in the late '80s and early '90s was it took some time for people to really reconcile.

Within our joint ventures where the stress exists right there with us within our partnership.

It is a straight negotiation, where we can figure out where the opportunity exists, and where common ground exists for the partner.

Okay.

And on those JVs, are you agnostic as to whether what the debt loads are, whether they are debt free, or meaningful debt?

We underwrite everything looking at it as a pure opportunity.

And if there is debt or no debt, we are going to deal with it the same way.

We are not interested in taking on additional obligations, where there isn't meaningful opportunity for our future.

Okay.

If volume stayed at roughly the level that we are running now, how long do you think it would take you to get to a normalized operating margin, looking at sort of what you talked about with the improvement in gross margin from your impaired land, and then moving your SG&A to a 10% type level?

What do you mean by normalized operating margin?

If you looked at, let's call it a single point number, 8%, for lack of a better point.

I can't guess.

You are embedding in your question a lot of assumptions, the market is staying where it is right now, and if there are no more downward trend and sales pace where it is now.

I am not even sure where it is right now.

Okay.

So it is as I said, you get very erratic weeks in terms of the sales pace in the field.

So it is kind of hard to make the assumptions that you are laying out, but we do anticipate given a fairly steady trend line, we do anticipate improving margins, net margins as we go forward.

How quickly we get to a net 8%, it is just too hard to call right now.

Okay.

Just one last question, your land supply that you have now, fairly heavy for current volumes.

Are you comfortable with that, or would you like to bring that down over the next year or two?

No, I think we are comfortable with that.

I think that at some point, I am not much into projecting right now, but at some point, our production levels are going to come back up, and the land that we have is going to be absorbed at a faster pace.

So I think that as we look at our land asset right now, I think that we have a sizable land asset from the standpoint of number of home sites available.

But that is going to hold us in good stead going forward, because I think that the business is going to come back.

There is going to come a time where this foreclosure problem starts to subside, and there is going to come a time where the demographics of this country starts to kick in again, and there is pent-up demand, and I think that the swing is going to with strong.

It just doesn't happen to be in the next couple of quarters.

Okay.

Thanks a lot, Stuart.

Our next question is coming from Nishu Sood of Deutsche Bank.

Hi.

This is actually Rob Hansen on for Nishu.

Just wanted to try to get an idea of what percentage of your lots are fully developed?

I don't have an exact percentage of how many are fully developed.

But in terms of dollars I can kind of give you a rough order of magnitude, that finished home sites are let's say approximately 900 million to 1 billion of our total inventory numbers that we gave out earlier.

Okay.

I also wanted to see if you could elaborate a little bit on the foreclosure competition.

Are these in your direct neighborhoods, or in adjacent areas, or something else?

Yes.

It is an interesting question.

We really have focused on exactly that question within each of our divisions.

And what we have found is that with the remaining communities we have, that is the communities that we have not walked from, the number of foreclosures actually in our communities are fairly low.

I am going to give you some numbers, and they are probably not good numbers, but they are kind of indicative of kind of order of magnitude.

But we found that there weren't really situations where we found more than say 20% of a community that had gone through elements of a foreclosure.

By the way, the term foreclosure seems to be confused throughout the industry right now.

Foreclosure is sometimes referred to as loans in default, or loans that are in the judicial process, or homes that have actually been taken back as REO, or have been sold.

And so we are looking at the whole span of homes that have either been sold as REO, or homes that are actually in a default process right now.

So that whole spectrum.

It has been a smaller percentage than we thought it would be, generally in the 20% range.

We are also finding that the clearing price for foreclosed homes has not taken as big of a dip as we thought they might.

And in fact they are selling somewhat, at least in our communities, selling somewhat close to the sales price that we are offering for new homes.

That is interesting.

Thanks a lot.

You bet.

Our next question is coming from Jim Wilson, JMP Securities.

Thanks.

Good morning, sorry for missing my spot before.

A couple of quick questions, I don't know if I missed it, but in the California impairment on the JV, is there anything there related to land source, like for the management contract or anything, or is that all from other JVs?

No, that would all be from other JVs.

Okay.

Just a second question related, in general anything you can comment on the shelf filing, and potentially uses on the obvious that it could be anything?

Is there anything it is targeted towards?

There is nothing behind that filing.

It is a filing that expired and in the normal course, we are just refiling.

There is really nothing to read into that, Jim.

Okay.

All right.

That is all I had left.

Thanks.

Okay.

Thank you.

Our next question is coming from Megan McGrath, Lehman Brothers.

Morning.

Thank you.

I just wanted to ask quickly about your incentives.

Ticked up a little sequentially, and up year-over-year.

So wondering if you could just talk about how your incentives have evolved, have the newer financing incentives, do you feel that they are working, and how they have changed over the past couple of quarters?

Yes.

The question of incentives is a very locally driven question.

What you are looking at at the corporate level is a roll up of a lot of very different programs, that are working differently in different markets.

So the incentive programs are left to our divisions, and are very much focused on driving sales, given current levels of market conditions, and really on a day by day, community by community basis, that changes around, to accommodate basically competing against our biggest competitor as I said before, and that is the foreclosure market.

So I don't think that there are trends that we can describe to you.

I think that you are actually seeing a lot of erratic data points, that are combining to look like a trend, and they don't really represent a trend.

Okay.

And then just a quick one for Bruce, your homebuilding debt looked like it picked up just a tiny bit quarter over quarter.

Did you put any JVs down on the books, or is that something else that is going on there?

There was a joint venture consolidation during the quarter, and that is the only reason that increased overall for homebuilding.

Okay.

Thanks a lot.

And our next question is coming from Dan Oppenheim, Credit Suisse.

Thanks very much.

Wondering if you can talk a little more SG&A.

You are talking about the outlook continuing to worsen, and weak absorption as it is right now, and goals for each market down 10% SG&A as a percentage of revenue.

How is it that you look at sort of managing that?

Clearly we are getting close to the point where you are cutting some bone in the markets.

What is it that is involved in cutting SG&A, where at this point where you still think you can cut away, and keep the business as we are going forward here?

Yes, that is a fair question, Dan.

Clearly, as sales pace is moving around, and primarily in a downward direction, and prices are moving down, getting to a 10% level on revenues, it is a tricky business right now.

And we are only as good as our predictions and projections.

And you also highlight that we have cut away some of the fat, and probably cut through some muscle, and maybe to some bone, but the fact is maybe at the end of the day, that we are getting down to a very aggressively thin group of professionals in each division, and we are consolidating divisions where possible, and really bringing the machine down to it's bare necessities.

I think that a lot of the opportunities to cut, comes from the ability to eliminate communities that are not performing well, so if some of our communities bleed off, that helps us bring down our SG&A, and other efficiencies that we see in the market, like consolidating some of our purchasing effort at either a regional or corporate level, or consolidating our marketing programs, and having them come from a corporate level.

And in each of these areas, we are looking at ways to take cost out of the operating division, and either combine them in order to generate efficiencies, or to just eliminate them entirely.

Okay.

Thanks very much.

You are welcome.

And our next question is coming from Jay McCanless, FTN Midwest.

Hey, good morning.

Good morning.

A couple of quick questions.

If I look at the dollar value of your backlog from the first quarter to the second quarter, it is the first time that has moved up in almost three years.

I just wanted to get, I know you don't make predictions, but given where the current situation is, et cetera, can we reasonably expect a return to that seasonal pattern where it builds first second and third, and then decreases in the fourth?

No.

I don't think that we can expect to read any, see any patterns reemerge for the time being.

I think that we are going to see some fairly erratic numbers that come through the system.

And really, what I back that up with, is just the view ahead to the foreclosure market.

I think if you look at the pipeline across the country, particularly in some of the biggest markets, the foreclosure pipeline, and that is the homes that are in default today, that are just entering the judicial process, it is getting bigger, not smaller.

And barring something being done at the Governmental level, I think that we are going to see more pressure going forward, rather than opportunity to see typical selling patterns reemerge.

So, a lot of the patterns we see, are going to be dependent on the inventory levels that are driven by the foreclosure market.

There are wild cards out there.

There are legislative opportunities that are in front of Congress right now, which could ameliorate some of these pressures, and we are just going to have to wait and see.

Okay.

Thanks.

Then my follow-up is on the incentives, I know that there has been significant advertisements on your websites, et cetera, for rate buy downs.

Is that the primary incentive you are offering now, or is it still a mix of option packages for the house, plus the rate buy downs?

How does the incentive picture look right now?

It is all of the above, but the rate buydown incentive is a significant one.

Okay.

Thank you.

You are welcome.

Our next question comes from Rashid Dahod, Argus Research.

Good morning.

Good morning.

In response to an earlier question, you had mentioned you expected correction of existing home prices, and some of the other builders have reported where their new homes are priced below comparable existing homes, I was wondering what markets you are seeing that in, or what percent of markets you are seeing that in as well?

Well, I think what is being highlighted is that the new home market corrected much more rapidly than the existing home market.

So what you are seeing at the existing home market is a number of homes that are on the market, at prices that are more reflective of yesterday's values.

And I think that this is a national phenomenon, not specific to any particular market.

Basically you haven't seen that reconciliation in the mind of the individual homeowner, to the fact that home values have diminished to the extent that they have.

And so we see this really across this country.

Now the foreclosure market is not having as much of a difficult time pricing, to where the new home market is.

Okay.

And then as existing home prices correct, what impact do you think that will have on the pace of new home sales, and what is your strategy?

That is a good question.

Listen, I think that as existing home sales correct more and more, it will put more competitive pressure, just because you will have more legitimately priced inventory in the marketplace.

But always remember that new homes compete very well against existing homes.

They come with a warranty.

It is not somebody else's footprint that is on the home, and so we will compete, and do compete very well against comparably priced existing homes, and in fact, the new home market typically trades at a premium to the existing home.

Now what I will say is that what you have seen over the past year or two, is a quick correction in the new home market, because the homebuilders have moved rather rapidly to reduce inventory levels.

And I noted in my comments that one of the positives that is out there is that the new home market inventory levels has come down precipitously, and that is a real positive for pricing power in the future.

Okay.

Thanks.

You are welcome.

And our next question is coming from Stephen Kim, Alpine Woods.

Hi.

I wanted to see if I can ask you a couple of questions regarding what might be considered to be a normalized pace?

I know I am going to get into a little trouble here, because you asked the other guy what normalized meant.

You indicated that your unsold completed inventory was down 47% from just the previous quarter sequentially.

And I have been noticing that your conversion rates, your backlog conversion ratio has been extremely high for really the last three, in fact five quarters now, almost 100%.

Given that you are not going to be delivering as many homes that were already sitting in your backlog completed, I would think that you might have, might see your conversion ratio decline, and therefore you would be doing more sort of build to order type of business.

Is that what we should be expecting from you as soon as this third quarter, or are there other factors I am not thinking about?

Well, at the same time that we are eliminating a lot of our inventory, our production cycle is coming down pretty quickly as well.

As part of our cost initiatives, we are also very focused on cycle time, and our cycle times have been coming down.

So that is going to offset some of that, Steve.

You mean your natural cycle time, as opposed to being influenced by cancellations, and things like that?

Right.

And I think that you are seeing a lower cancellation rate.

I don't know that we will sustain a 22% cancellation rate, but I suspect it is going to be lower than where we have been over the past three years on a consistent basis.

We are absolutely more focused on selling homes that are not under construction, and there is more of that, but we think our delivery time on those homes is going to improve as well.

So our backlog conversion ratio will move around a little bit.

We think that there will be some offsetting inputs to that on both sides.

Well, then that result should be I would think some reduction in overhead carry, and that sort of gets to my next question which is your SG&A rate.

You talked about a divisional SG&A rate of 10% as your goal.

I just hadn't heard you talk about that in prior years.

I just want to make sure I am understanding, does a 10% divisional SG&A rate, pretty much aggregate up to a 10% SG&A rate as a percentage of home sale revenues that we would see on your income statement, or is there some adjustment factor that you can give us?

Number one, the answer to the last part of the question is, yes, it should be.

It should reflect on the income statement at that level.

And you are right, we haven't really talked about it much.

This had has been a primary focus over the past year to 1.5 years, and I just haven't wanted to talk about it until I see real progress in the field.

This last round of ops reviews gave me a level of optimism about where we are actually going to, where we are actually going to land here.

Now might it move around, because volumes aren't where divisions expect them to be or something.

It is possible.

But we have made a lot of progress in this arena.

That is encouraging.

Does that suggest that your breakeven point in terms of absorptions per community to breakeven profit-wise is reduced, versus let's say where it was two or three years ago?

No, it is reduced materially.

David.

Go ahead.

I was actually, okay.

But no, it has come down materially, Stephen.

Okay.

Great.

Thanks very much.

Thank you.

We will take one last question.

And that last question is coming from Alex Barron, Agency Trading Group.

Hey, guys.

Thanks.

I don't know if I missed it, did you mention what the cash flow from operations was for the quarter?

We didn't mention it yet, because the cash flow statement isn't completed, Alex.

But essentially cash quarter-over-quarter was reduced about 200 million in total.

Okay.

Thanks.

My other question was, as I know you guys have already sold some land, but of the communities that you currently own, I was wondering what percentage of those have been impaired at least once?

Currently of our total communities we have impaired 5% this quarter.

We don't really track a cumulative percentage count.

But we have impaired about 5% of our communities that is in our second quarter number.

Okay.

I guess the other way for me to say that, would be we have impaired 100% of the ones that should be impaired.

Okay.

And I am sorry that we are not really directly answering your question.

Right.

Could I just ask one quick one.

In terms of how, I know you guys have been doing these financing incentives of rate buydowns, and paying closing costs, and down payment assistance.

How is that accounted for, is that in the cost of goods sold, in the SG&A, or how does that flow through income statement?

That is included in sales incentives, which is is a reduction to revenue.

So it factors into the gross margin calculation, 100% of it.

So it is basically the revenue is what is adjusted?

Yes, sales incentives are a reduction of revenue, and 100% of any costs relating to a buydown program, is included in sales incentives, which is a reduction of revenue.

Okay.

Got it.

All right.

Thanks a lot.

You are welcome.

Okay.

Well, that will be the last question for this morning, and listen, we appreciate everybody's attention as we report our second quarter.

We are optimistic about our progress, and where we are in this tough market condition, and we look forward to reporting our third quarter.

Thank you.

This will be the conclusion of today's conference.

All parties may disconnect.