Lennar Corp (LEN) 2010 Q2 法說會逐字稿

Welcome to Lennar's second quarter earnings conference call.

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

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

Today's conference is being recorded.

If you have any objection, you may disconnect at this time.

I will now turn the call over to Scott Shipley, Director of Investor Relations, for the reading of the forward-looking statement.

Good morning.

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

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

Forward-looking statements represent only Lennar's estimates on the date of this conference call and are not intended to give any assurance as to 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, most recently filed with the SEC.

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

I would now like to introduce your host, Mr.

Stuart Miller, President and CEO.

Sir, you may begin.

Great.

Good morning.

Thank you for joining us for our second quarter 2010 update.

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

Additionally, we have Rick Beckwitt here, our Executive Vice President, who will be available to answer questions.

And Jeff Krasnoff, the Chief Executive Officer of our Rialto segment.

I'm going to begin with some opening remarks about the current housing market in general and the progress that we've made on managing our balance sheet and our joint ventures.

And since we've just finished our quarterly operations review, I'm also going to share with you our views on our home building operations as well.

Then Jeff is going to comment on our Rialto segment positioning for 2010 and beyond.

And, finally, Bruce will provide additional detail on our numbers.

And then, of course, we will open the phones to your questions, and and as always I would like to request that in our Q&A period everyone please limit to just one question and one follow up so that we can be as fair as possible to all of the participants.

So let me begin and make just a few overview comments about the market and about our second quarter.

To begin, let me say that we are very pleased that our second quarter results represent a fundamental return to profitability for Lennar, with earnings per share of $0.21 versus a loss of $0.76 last year.

We posted solid operating performance from our home building segment, our financial services arm, and we saw our first profits from our newly formed Rialto segment.

At the same time, we saw valuation adjustments, or impairments, substantially reduced from just under $100 million second quarter last year to $6.1 million this year.

Accordingly, we remain confident that we will be profitable in 2010.

But, while we feel comfortable that we positioned the Company for current market conditions, we realize that the greater focus of the investor community is on questions concerning the road ahead.

In my remarks last quarter's conference call, I noted that the recovery in housing is not presenting itself as a V-shaped return to better times, but instead is proving to be a rocky, stabilizing bottom with visibility obscured by more questions than clear answers.

At that time, while the housing market seemed more stabilized than today, we knew and expected that the end of the $8,000 tax credit in April, that it kick started the housing market back to life, would draw demand forward, and leave a void that would have to be filled by free-market forces driven by low, affordable home prices, and historically low interset rates.

We knew at the time that this void would not feel good, and it doesn't.

Today's reality is that the new home market and housing in general still face serious headwinds from current economic and legislative conditions.

Nevertheless, we are still confident that the housing market and the overall economy are continuing to stabilize and are generally in recovery.

With that said, the current reality is that the overhang of foreclosures and the prospective additional delinquencies ahead continue to moderate this recovery, as shadow inventory continues to be absorbed and even replenished.

Unemployment and a generally sluggish economic bounce-back combine to hold demand at traditionally low levels, while the reality of the pullback, driven by the elimination of legislative and fiscal incentives, limit visibility and create pending uncertainties about the immediate future of the strength of the market.

And finally, debates over whether inflation or deflation lies ahead and the impact of sovereign credit risk continues to add uncertainty to the view ahead.

Over the past couple of days, we at Lennar have carefully reviewed our operations with our regional and our division presidents.

After careful review, we continue to be inclined to believe that the current pullback in demand is temporary and the void left by the expiration of the tax credit will be filled in the upcoming months by purchasers looking to take advantage of historically low interest rates supporting the purchase of extremely well priced homes.

As we reviewed our operations from the field, geography by geography, we heard some common themes that continue to appear to validate the overall trend toward stabilization of the housing market.

First, prices are not free falling in the face of the moderation in demand.

And in fact, in many markets, prices are continuing to stabilize and even modestly recover.

This is primarily because inventory of new homes are low and have remained in check.

In most of our divisions, there continues to be a meaningful reduction in the incentive used -- incentives used in the sales process, and that fact is reflecting itself in higher gross margin.

For the Company overall, incentives were 11.5% this quarter, down from 12.5% last quarter, and 17.3% last year.

And margins improved on a pre-impairment basis to 21.4% from 20.3% last quarter, and 14% last year.

While in the short-term, incentives might creep up, the general consensus among our divisions was that the use will be limited.

While this trend is vulnerable to the gyrations of the stabilization process, it seems that the momentum provided by consumer confidence, a generally improving and stabilizing economy, low interest rates that are likely to remain low, and home affordability, will likely equalize their impact over a short period of time.

The free market seems well positioned to take over from stimulus in a fairly orderly fashion.

Next, inventories of new homes, as I said, remain significantly reduced.

While there's been a great deal of talk about spec building of new homes to beat the end of the tax credit, we found from the field that this was limited to a very few markets.

In most markets, new homes were and are still being built to order, and for the segment of the market that wants a new home, there are really limited immediate opportunities to choose from and that's helping prices and incentives to stabilize.

Next, we heard that while foreclosures continue to be a significant driver of absorption and pricing, the affect continues to decline, as the bulk of foreclosure activity is situated in areas that do not compete with new home construction, such as the inner city and the extreme outskirts of the markets in which we operate.

As I've noted many times before, housing is a very localized business and inventories, and micro-market, not broad markets, are most important in considering demand trends.

In our reviews with our divisions, we are finding -- we found that there are very few foreclosures in the communities in which we are, in which we are building, or in direct competition, or are in direct competition with our product.

The better situated foreclosure homes have been, and are continuing to be, absorbed in an orderly fashion and the market is clearing the inventory overhang in many locations.

The $8000 tax credit facilitated that clearing process and we think that low prices and low interest rates will facilitate a continuation of that process.

Finally, we also heard from our division heads that the employment rate in many of our markets continues to be at least stabilizing and in some instances, beginning to recover.

According to -- accordingly, a general sense of confidence is continuing to return to the consumer and there's a tangible sense that with prices and interest rates low, now is the right time to purchase a home for future security.

This is perhaps the most important element driving the future of the housing market, as the threat of losing one's job has deterred many from the housing market for some time now.

Even with the current pullback in demand, we feel that our strategy of focusing on high margins and controlled volume, controlled costs, and controlled G&A will continue to benefit us and enable us to remain profitable as the ground continues to find stabilization beneath us.

We've continued to make carefully underwritten strategic acquisitions in well positioned markets that support our home building business going forward, and we've been able to find acquisitions of home sites to build new communities where homes can be delivered at a responsible profit level at today's price level and given zero market appreciation.

Our home building machine is operating very well in these difficult market conditions.

Additionally, as noted in our press release, our balance sheet remains fortified with a home building debt to total capital ratio net of home building cash of 42.2%, and home building cash of approximately $1.1 billion.

We also fortified our balance sheet this quarter with a strategic combination of convertible notes, 8-year bonds, and debt repurchase that Bruce will review in just a few minutes.

We've also continued the process of reducing the number of our joint ventures, which has fallen to fifty-three currently, and down from fifty-eight last quarter.

Many of these remaining joint ventures are good ventures that have already been reworked and have solid assets that are positioned for the future.

And we expect to continue to reduce this number as we go forward through 2010.

Additionally, we've continued to reduce the maximum recourse debt to the Company, which is now at a level of $234 million and is down from $275 million just last quarter.

Finally, on the opportunity side, our first strategic investment in the Rialto segment of our business are beginning to show the value of this business opportunity.

As I noted in prior quarters, we've been preparing to be a significant participant in the distress opportunities that naturally present themselves in down cycles.

We've been incubating an operating team of experienced professionals for the past 3 years.

The team is formed and is operating and our first investments are really proving up.

While I'll let Jeff Krasnoff update you on these programs, I will note that we've made a meaningful investment -- that we've made meaningful investments, and we believe we will add significant shareholder value as we go forward.

This is a tough business that we do exceptionally well.

Earlier this week, we had our weekly asset managers meeting, and as I have reviewed each week, our assets with our asset managers from around the country, I continue to become increasingly enthusiastic to see just how comfortably we operate and manage this very unique segment.

We are clearly beginning to see more opportunities present themselves in this area and with our unique expertise, we expect to be an active participant in this part of the market recovery as we feel these investments can add outsized returns to our recovering home building operation.

At the end of the day, we are very pleased with the progress that we've made to date and are very excited -- and are very excited about the position that our Company is in, even in the difficult market conditions and uncertain times.

Our balance sheet is strong and well positioned with liquidity to support investment for the future.

Our core home building operations are lean, right-sized, and well positioned for success and they are beginning to grow again, adding communities and leveraging our overhead.

And our Rialto investment segment is now fully operational and investing capital to create strong returns as we build profitability.

While we recognize that the current economic environment is fragile, we feel today that we are extremely well positioned to navigate the rocky bottom and ultimate recovery that continues to lie ahead.

And we continue to feel comfortable that we'll be profitable in, and in each quarter, in 2010.

Now, let me turn it over to Jeff Krasnoff to give you some additional color on our Rialto segment, and then over to Bruce for additional color on our numbers.

Thanks, Stuart.

Good morning, everyone.

While we started building the Rialto team here inside Lennar almost three years ago, it was just last quarter, coinciding with the closing of our first two distressed asset portfolios in partnership with the FDIC that Lennar announced a new Rialto investment segment.

And now, as Stuart has already indicated, the Rialto segment is profitable.

As Bruce will walk through in a minute, the main contributors to this is our 40% share of the FDIC transactions, our public/private investment fund activities with Alliance Bernstein and the US department of treasury, or PPIP, and the management fees from both these programs.

Some of you may be familiar with the disciplined process that we've employed over the years, the looking at large portfolios of assets based on a careful review of underlying collateral value, loan documents, and borrower and guarantor capabilities on an asset by asset basis.

Our detailed due diligence reviews, combined with our resolution process and real estate operating capabilities allows us to look at these portfolios on a wholesale basis and through our operations, bring value to individual assets on a retail basis.

And because of the high content of loans made to developers, having Lennar's unique view, we believe gives us a distinctive advantage in our evaluation of these assets.

For our first two FDIC portfolios, for instance, we worked for over four months on the underlying due diligence.

During the quarter, we finished the process of bringing all 5500 of the loans in these FDIC transactions on board from the twenty-two different receiverships.

We also made great progress in reaching out to borrowers, while at the same time building out the core of our operations team to create value from these assets.

We now have seventy associates focused on our portfolio operations, including loan workout, property asset management, servicing, finance, and back office operations in three offices, located in Miami, Atlanta, and New York.

And our team contains a lot of familiar faces, a number of whom were here a couple of decades ago when we did something very similar.

By leaning on Lennar, we clearly had a head start in being able to set up our infrastructure very quickly.

We've also been able to employ the servicing and small balance loan collections resources of Clayton Holdings, a company in which we made a small investment in 2008.

We're already deep into the portfolios.

We have our operations team focused on the top 550 borrower relationships, which makes up over 85% of the total $3 billion of unpaid principle balance in these two transactions.

We've already had direct conversations with about 90% of these borrowers and related guarantors by balance and have had meetings with over half of them to resolve their loans.

A number of relationships have already been resolved and many are in progress.

With our early activities, we've collected over $60 million of interest and principal, about 20% of which were full payoffs at par plus accrued interest.

And cash flow's been used to pay the operating cost of the portfolio including fees to Rialto for managing the process, and as of the the end of the first full quarter, we had already reduced the FDIC financing by $34 million to $593 million.

Our PPIP program continues on course as well.

During the quarter, our team wrapped up our private equity raise topping out at $1.16 billion.

With the matching equity from US Treasury and advantageous LIBOR plus 1% 10-year financing, our fund has $4.6 billion of purchasing power.

We have committed $75 million of equity to the program, which is now 85% drawn.

With our disciplined approach to focusing on resilient cash flows, we have now acquired approximately $3.3 billion of residential and commercial mortgage backed securities.

We are also very pleased with the underlying performance of our portfolio, and believe we are on track to achieve the types of returns we had anticipated when we purchased them.

With the stepped-up efforts of the FDIC, and more recently some of the banks themselves, the pipeline of opportunity, as Stuart mentioned, continues to expand.

Our due diligence team is currently evaluating several billion dollars of opportunities today, assisted by our core operations group that is deeply involved in many of the markets working out the assets.

And of course, the Lennar home building team.

As we go through this process of reviewing distressed assets, we also look forward to finding new opportunities for the home building side of the business.

And along those lines, we've already helped to tie up over 700 home sites in nine different communities for the Lennar home building divisions.

The Rialto team is very excited about our position today and we look forward to reporting to you on our progress in the future quarters.

Now I'm going to turn it over to Bruce.

Thank you, Jeff, and good morning.

Our road back to profitability this quarter included positive operating earnings contributions from all three of our business units.

Our home building business unit had operating earnings of $29.5 million during the quarter, and that's compared to a loss of $116.5 million in the prior year.

Revenues from home sales decreased 12% to $695 million due to an 8% decrease in home deliveries, excluding JVs, and a 5% decrease in average sales price to $240,000.

The overall average sales price decrease was partially due to fewer deliveries from the West segment, which had a higher average sales price than the Company's average.

The average sales price changed regionally year-over-year as follows.

The East region was up 1% to $222,000.

The Central region was up 1% to $198,000.

The West region was down 9% to $318,000.

Houston was up 8% to $217,000, and Other was down 7% to $253,000.

Our gross margin increased 1100 basis points inclusive of impairments to 20.6% compared to the prior year.

This improvement is primarily due to a significant reduction in sales incentives and the decline in valuation adjustments that Stuart mentioned.

Sales incentives declined from $53,000 per home in the prior year's quarter to $31,000 per home in this quarter.

That was a reduction from 17.3% of home sales to 11.3% of home sale revenue.

The sequential improvement was also 100 basis points from the first to the second quarter, in looking at sales incentives as a percentage of revenue.

And the lower sales incentives per home delivered is a result of not only the improved selling environment that we had in the first part of the year, but our repositioned product strategy, as well as fewer completed unsold homes.

Additionally, the impairments were down from $99.1 million to $6.1 million in the current year's quarter.

We are continuing to realize the benefits from our aggressive cost cutting measures and lower non-recurring expenses in areas of legal and occupancy costs, which helped us to reduce SG&A costs by approximately $15.7 million, or 14% year-over-year.

SG&A as a percentage of revenue from home sales was 13.9%, which improved 40 basis points from the prior year, and 190 basis points sequentially from our first quarter.

The fundamental success with our improved gross margins and reduced SG&A led to an operating margin of 6.7%, and that's the highest operating margin that we've seen in four years.

Turning to our financial services business unit, they generated operating earnings of $13.7 million versus $16.5 million of profit in the prior year.

This was the result of lower volumes in both our mortgage and title operations.

Mortgage pretax earnings was a profit of $9.3 million versus $14 million in the prior year, and our title company had a loss of $400,000 versus a $3.2 million profit in the prior year.

Additionally, our financial services segment recorded just over $5 million of profit relating to the collection of a deferred payment from the previous sale of the cable system.

Following up on Jeff's description of Rialto, our third business unit, we generated operating earnings totaling $5.1 million during the quarter.

When you look at our income statement, the $5.1 million is the netting of $14.7 million of Rialto operating earnings, less the $9.6 million included in the line that's called Net Earnings Attributable to Non-Controlling Interest.

As we reported last quarter, we consolidated the FDIC portfolios and therefore our second quarter numbers reflect all the activity from the FDIC portfolios with an offset attributable to non-controlling interest.

The summary of Rialto's $5.1 million of operating earnings is $9 million of earnings from our 40% share of the FDIC portfolios plus management fees relating to the FDIC portfolios, plus $1.6 million of earnings from PPIP, less approximately $5.4 million of G&A expenses.

This is the first quarter of revenue contribution from the FDIC portfolios acquired in February 2010.

Management fees and accretable interest income net of expenses from these portfolios totalled $9 million.

Revenue recognition from these portfolios is recorded based on the expected cash flows from the portfolios to calculate accretable interest income.

These cash flows include both expected loan payoffs and interest income.

As Jeff mentioned, the cash flow generated during the quarter was used to [difese] the debt and we did reduce the FDIC debt from $627 million to $593 million during the quarter.

PPIP management fees and interest income were $1.6 million and the PPIP fund has already started distributing cash flow from these earnings back to the partners.

Included in these summarized numbers are approximately $2 million of start-up expenses relating to the two FDIC portfolios.

These are non-recurring costs and are included in both the FDIC and G&A numbers I mentioned above.

Turning to corporate items, other expense includes $10.8 million of expenses associated with our $289 million debt tender during the quarter and that was partially offset with a gain on retirement of bank debt at a discount of $4.3 million.

Corporate G&A expenses were reduced by $7.5 million, or 25% during the quarter versus the prior year, and the reductions were a result of successful cost reduction initiatives in the personnel, occupancy, IT, and legal categories.

Taxes, if you look at our tax filing, you'll see that there was an $11 million benefit during the quarter relating to the resolution of the uncertain tax positions previously recorded.

And as we turn to the balance sheet, our home building cash inclusive of restricted cash, totaled $1.2 billion during the quarter.

We issued $250 million of 6.95% senior notes due 2018 during the quarter, and $276.5 million of 2% convertible debt, up 38%, with a conversion price of $27.64 during the quarter, and that's due 2020.

While repurchasing through a tender, $289 million of the aggregate principal amount of senior notes that wer due between 2010 and March of 2013.

These transactions enhanced our balance sheet strength by pushing out our near-term debt maturities and adding liquidity to the balance sheet.

In addition to the tender, we repurchased $38 million of senior notes due 2010 and 2011.

Our leverage remained low, as Stuart mentioned.

Homebuilding debt to total cap was 42.2% in the second quarter, net of our cash.

And we made tremendous progress on the joint ventures.

Of those fifty-three joint ventures we discussed, twenty-three have no debt, fourteen have non-recourse debt, and only sixteen have any recourse debt at all.

We made tremendous progress on reducing our joint venture recourse indebtedness with the joint ventures, reducing it by $45 million sequentially from last quarter to $234 million, and net of reimbursement agreements, it was down to $146 million.

We continued to carefully manage our inventory and we ended the quarter with very few completed unsold homes, averaging between one and two per community.

We closed on approximately 3,000 home sites during the quarter, totaling $109 million of purchase price, in well-located, ready to go communities.

Additionally, we've put approximately 1400 home sites under option contract during the quarter, and our overall inventory dollars remained flat with the prior year at $3.7 billion excluding consolidated inventory not owned.

There were approximately 3300 starts during the quarter, which was up 20% over the prior year, and there were 2000 -- I'm sorry, 82,000 home sites owned and 22,000 controlled at quarter end, totaling 104,000.

The Company's strategies have positioned us well to continue to generate profitability in all three of our business units and our balance sheet if financially strong to capitalize on additional new investment opportunities.

With that, let me turn it over to the Operator for questions.

(Operator Instructions) Our first question comes from Ivy Zelman of Zelman and Associates.

Good morning, guys.

It's actually Alan on for Ivy.

I appreciate your commentary on May there.

I was wondering if you could chat a little bit about the upcoming deadline for the closings of the tax credit?

When you think about your backlog of about 2500 homes, what would you estimate is potentially at risk of not closing in time for the June 30, 2010 deadline that maybe previously you would have thought it would have closed?

I know the NAR was out this week with an estimate that 180,000 or so home buyers that thought they were getting the credit, may not close in time, so I was curious if that's a problem that you foresee?

Yes, this is Rick Beckwitt.

We've carefully mapped out construction schedules associated with anything that was sold with the tax credit in mind and across the board, we have maybe one or two, or a handful of things that are at risk, and I believe that all those will close within the deadline.

Have no (inaudible) at all.

Okay, great.

Got you.

Thanks, that's very helpful.

And then just on your commentary a little bit, Stuart, about incentives maybe creeping up in the near term, how would you expect that to flow through to the margin over the next couple of quarters?

Do you think that that's going to have a downside impact on margin?

Or is there enough impact from maybe some new projects coming online to maybe offset that?

In other words, do you think margin continues to move higher from here despite the higher incentives in the near term?

We had a lot of discussion about this with our division people, and we really drilled down on their view, given what has been a moderating traffic pattern and the demand in May 2010 and even flowing into June 2010.

And the perspective is that there might be some movement on incentives just to keep the market moving forward, but that it would be fair -- it would be pretty limited.

I think you properly highlighted that we do have some new communities that are starting to come online and contribute a little bit more to our margin.

And we would expect -- I don't want to give a projection, but we would expect pretty good stabilized and even improving margin picture as we go forward.

I guess the thing I would add to that is we are getting a benefit with construction costs going in our direction.

We've seen an improvement in lower cost of lumber and some other of the materials that we are incorporating into the homes.

So I think some of that potential price decline on the incentive side will be offset by some of the cost to build.

Great.

I appreciate that color.

Thanks guys.

Our next question comes from Joshua Pollard of Goldman Sachs.

Hey, good morning, and thanks for all the detail.

You talked a little bit about June, but I was wondering if there was somehow you could characterize what you're seeing throughout June?

Is it improving as the month is going along?

Are you guys not seeing a ton of -- you know, how would you characterize sort of stabilization for June?

Yes, it's Rick.

We typically don't like to give any color on the quarter that we're about to enter into, but we know there's a lot of focus on June and what's going on.

I can tell you, on a seasonal basis, it's a slower quarter on a just the annual year.

We have seen seen modest improvement over May and right now we're running, let's say, 25% off of the prior year.

You know, it's choppy, we don't have a lot of data right now.

We're (inaudible) on the fact that we've got a good, stable backlog going the quarter.

And as Stuart said in his remarks, we think that buyers will re-emerge and this has just been a temporary slowdown in the market.

Yes, I think (inaudible) that there was a sizable pull forward of demand in April in order to accommodate the $8,000 tax credit and its termination, but as we've gone through May and as we're coming into June we're feeling that, that demand is, is starting to make a modest recovery.

So, the sense from the field -- and there's no certainty in this -- but the sense from the field is that as we go forward, it's really going to be low interest rate and the affordable pricing of homes that's going to, that's going to enable the free market to take over and stabilize.

That's extremely helpful.

My other question is on Rialto.

We've had conversations at a lot of FDIC loan purchasers.

And one comment was about a barbell approach to the revenue recognition.

Up front, there were folks you hadn't talked to in a while who hadn't heard from their loan servicers for months and even years.

When you guys come in and send the hello/good-bye letters, that actually accelerates some of the revenue up front, and then you see another acceleration of revenue towards the end.

Is that what you're expecting?

Or should we sort of think about the revenue trajectory that you guys have printed in this first quarter to be somewhat of a run rate going forward?

Yes, well I, I would -- my first comment -- this is Jeff.

Is that, that is, that is what you've described is fairly consistent with what we've seen I guess really over the last 20 years or so in doing this workout business, is that upfront that there are some guys that do come in with cash and they're just waiting for someone to call them.

But, but over time -- and then there are some assets that eventually might come back in foreclosure and it might get resolved a little bit later in the process.

So there is somewhat of a barbell effect.

From an accounting perspective, the way that the literature works, it's really recorded over a period of time based on -- what's it called, Bruce?

The level yield (inaudible).

Accretable

Accretable yield method.

So, so that's really built in.

We have an underlying business plan.

We go asset by asset.

(Inaudible) business plan for each and every asset, which is then verified by whatever modification we go through with each of the individual borrowers, so it's not unexpected.

So, so is it a way to think about it, even if you get additional cash flows above what you were expecting that it would actually turn into -- there would be no effect on revenues as -- or almost straight-lining it?

Well, what we would do there, Josh, is we would adjust our expected cash flows.

So to the extent you're receiving more than expected, you would adjust those expected cash flows and you would increase the revenue recognition in the current quarter.

Okay, great.

Thank you very much.

That's helpful.

On a go-forward basis.

And on a go-forward basis.

Okay, understood.

Thank you very much.

Our next question comes from Michael Rehaut of JPMorgan.

All right, thanks.

Good morning, everyone.

First question, I was wondering if you could kind of review, and we appreciate all the color in terms of May and June.

Any distinction across the different markets you operate in?

We were recently in California and saw, or believed that that market is held up on a relative basis somewhat better than the nation in terms of pace and price.

Any kind of markets that are stronger or weaker relative to this post credit world?

Let me give you a general answer.

Maybe Rick will think about it for a second and drill down a little bit more.

But the answer to your question, Michael, is all of the markets are reacting a little bit differently.

It's a real micro market driven business right now.

Where the foreclosures are makes a difference.

Where the builders might have built some inventory makes a difference.

There are some markets that have held up very, very well.

There are some markets that are faltering.

I think that are parts of California that are doing, that are doing pretty well, but contrary to what people think, there are some parts of Florida that are doing pretty well as well.

Probably, one of the leaner markets right now would be some of the Texas markets and primarily Dallas.

So Rick, maybe you would want to add to that?

You know, pricingly, Florida is some of our strongest markets right now.

I think we're benefiting from the fact that we put under contract a fair number of communities that were attractibly purchased or contracted, so we're getting some good traction there.

As Stuart said, Texas is somewhat soft.

It went into the downturn on the tail end.

Dallas is a pretty tough market.

Houston is a little better, and you're seeing probably one of the strongest markets in Texas is San Antonio.

The Carolinas are a mixed bag.

Raleigh better than Charlotte.

In the Mid-Atlantic, we're seeing continued strength stemming from the government spending in Maryland and Virginia.

Jersey's pretty decent.

In California, it's very, very community specific and the better communities are doing better and the ones that are more tertiary are dragging, dragging along.

I think across the board, we have seen what I would call quality traffic, people understanding that affordability is at a level where it makes sense to buy a home, and they are just really trying to make a determination as to when they are going to pull the trigger.

And that's a sense really across the nation right now.

Great.

That's a great rundown.

Appreciate it, Rick.

And second question, in terms of communities, I know you guys don't break it out typically, but I was wondering if you could give us a sense of at least where you are in terms of your community count relative to last quarter and last year?

And where you expect that -- do you expect communities to be be up year over year by the end of your fiscal year?

And how are you starting to think about 2011?

Sure Mike.

Community count ended at about 426 this quarter.

It was up about 40 from last quarter.

So, we are seeing with the land purchases we've made, we're continuing to open new communities and we would expect to open new communities throughout the year.

And that number will grow and will be somewhat dependent on which deals we go forward with, but we would expect that number to grow throughout the year.

And what was it a year ago?

A year ago, it ended at 435 at the end of the second quarter, but keep in mind during the second quarter last year, it was declining.

So we had reduced that number by 20 or 25 during the quarter last year.

Great.

Thanks a lot.

Our next question is from Jon Ellis of Merrill Lynch.

This is Jay Chadbourne for Jonathan Ellis.

I was looking for -- what was your target, what is your target land and lend of open spending for 2010?

We, we haven't laid out a target, but in the current quarter, the land development spend was somewhere in the mid $30 million range for the quarter.

Okay, and the second question I had was what was the deferred tax valuation allowance at the end of the quarter?

It was approximately $650 million.

Okay, thank you.

Our next question is from Adam Rudiger from Wells Fargo Securities.

Hi.

Can you talk about how the orders -- I think you mentioned that June was better than May, and you said it was down about 20% to 25% so that suggests May was down worse than that.

Can you talk about intra-quarter order trends?

What they were like in all three of the months on a year-over-year basis?

Yes, you know, you saw the numbers yesterday.

New home sales down 32.5% in May.

I think that we saw, you know, progressively through the quarter better sales in March, fewer in April, and May was down materially.

And then as we noted, June's got feeling a little bit better.

That's kind of where we are.

Okay.

And then, I know you talked about it a but, but Rialto revenue recognition, how much of the revenues that you recognized this quarter were cash revenues?

Well, again, as you look at the revenue recognition, it's based on expected cash flows.

Okay?

So when you look at the revenue, there was $34 million, I think, was the number, of revenue.

And as Jeff mentioned, we brought in approximately $60 million of cash flow before expenses in Rialto.

Net of the expenses, Rialto brought in close to $40 million during the quarter.

Okay, thank you.

Our next question is from David Goldberg of UBS.

Thanks, good morning, everybody.

The first question I wanted to get into, Stuart, I wanted to delve into your comments a little bit about the incentives and keeping the market moving.

I would suspect that at this point in the cycle, you had a lot more control over the incentives that you're offering, whether you're deciding to offer more incentives or fewer incentives, and how you're thinking about base versus price at this point.

And I'm wondering kind of how much control corporate is having in overseeing individual divisions?

And specifically, are there some kind of hard targets from a sales perspective, that the answer is, hey, look, if you're not selling this many homes or kind of achieving these targets, you need to start layering in some more incentives?

Or how are you thinking about controlling that from a corporate perspective?

Well, from a corporate perspective, we have identified what we think appropriate absorption pace should be for every community that we've got.

We've got it targeted by week, by month, by quarter.

We, through our regional presidents, review traffic trends, sales absorptions, pricing trends and we've set paces.

We've identified where we want margins to be and as you know, it's a give/take with regards to absorption and margin.

So we are constantly tinkering with those push/pulls.

Some of it's driven by what the competition does out there.

As one of the competitors drops prices or raises price, it has an impact on what we do as well.

But we are really across the nation right now, very close to trends and traffic and sales.

So it's something that we monitor from sort of the mother ship up here.

But a lot of the day to day decisions are made by the guys running the divisions.

So just to understand, there'll be changing incentives?

There's no kind of hard and fast rule, but at this point we kind of feel like we'll rather slow the sales pace down and if that means in holding incentives steady it's much more fluid than that?

Is that that way to think about it?

Well, it is fluid like that.

But as Stuart said in his opening remarks, we are very focused on improving margins at the expense of doing volume.

We've got the SG&A down to a point where if we produce a good gross margin, we're going to make money.

Right.

That's what the divisions are focused on.

They want to be profitable.

Yes, but with that said, let's recognize that, you know, the, the ability to kind of hold margin and to measure the response to a slower market is enhanced by the fact that, as it relates to new homes, there's not all that much inventory on the ground in most markets.

And even the foreclosures in most of the markets in which we're operating are fairly light.

We really spend a lot of time with our division presidents on this the past couple of days.

Our perspective is if we've got a lot of foreclosure inventory, it might be an opportunity to purchase that inventory and make money on that.

The fact is that there's not that much of it in the communities in which we're operating.

We're really enabled to kind of hold price and to get pretty close to our volume expectation.

As Rick noted a little earlier, we are able to hold margins as we're maybe forced to bring prices down a little bit because generally the construction costs are going down at the same time as volume goes down.

So, you know, we have really been able to maintain our volume pretty close to our targets and also hold margin.

Great, and then just as a follow-up question, this is a little bit more broadly based here, but I'm thinking about as we look past the next couple of months and the new congress eventually coming in and who knows what the makeup will be like, but it seems like GSE reform is something everyone's looking at.

And I'm trying to get some perspective on where the builders should be?

Should the builders have a seat at the table?

Do they have a seat at the table?

And kind of what your expectations are given the amount of experience in the room in some of these topics, how the builders are thinking this might play out and what kind of precautions you're taking in case we see some hits in mortgage liquidity?

You know, will the builders have a seat at the table?

It's -- that's a question I, I'm just not sure that -- how that will present itself.

It certainly seems that there will be at some point a lot of attention paid to the GSE's.

I think that everybody, everybody's going to recognize that the builders -- and frankly the housing participants, housing market participants in general are going to want to see a program, whether it's GSE focused, or private sector focused, that it keeps available capital -- that keeps capital available to the housing market.

How that's going to present itself, I think that -- I think everybody's going to have some kind of voice, but it's going to be a complicated task to figure out where we go from here.

There's no question that at some point the government's going to have to pull back from supporting the capital markets as it relates to housing.

But it behooves everybody, and I think everybody recognizes how important it is, to do it in a very orderly fashion.

The free market will at some point take over, but, but doing anything too suddenly could derail the entire recovery.

And I think everybody is acutely aware of that.

Great.

Thank you for the insightful comments.

Our next question is from Dan Oppenheim of Credit Suisse.

Thanks very much.

I was wondering if you could talk a little bit about the comments in terms of profitability in each quarter and the attention out there in terms of whether this is a short-term issue in terms of demand versus something that persists for a little bit longer in that if we see the volumes slowing, it ends up creating issues in terms of SG&A.

How committed are you to -- so that profitability in each quarter as it might mean cutting overhead more, versus wanting -- be willing to tolerate higher SG&A in the short-term and potential lack of profitability the latter part of this year, if the lower volume persists?

I think we feel pretty strongly, Dan, that we've, that we've positioned the Company for market conditions that are where they are and even for some further tightening.

I think that we're operating at, at as high a G&A level as, as we could operate.

And I think we're pretty well positioned for the market as it moves forward to be able to maintain that profitability.

We've got a really excellent machine that's working very, very well.

Of course a significant downturn in the market could change that.

And I don't want to mislead anybody.

But we have -- we've spend a lot of time with our divisional people thinking about market conditions, potential size of pullback, potential stability, where we think things are going to go, and the general sense is that we're going to be able to maintain levels of profitability as we go forward and we're really committed to that.

Okay, and then secondly, was just wondering about recent comments that you made in terms that you've been able to maintain the volume close to the targets.

Is that still consistent in terms of the May/June order activity?

Or is that more just in terms of what we're thinking in terms of closings for the most recent quarter?

Well, keep in mind that it's a seasonal business and we don't just flat line what our expectation for sales are across the year.

We know that as you head into June and July, people are vacationing.

Gets a little hot.

And people don't necessarily want to be shopping for homes all the time.

That being said, we are pretty much on track with what our expectations are and what we budgeted.

So down 20%, 25% is the expectation?

No, that was from the prior year.

Right.

So, we knew that there would be a fall-off in activity when the tax credit expired.

And we are pretty much in line with where we thought we would be based on that demand going into the (inaudible) area.

Frankly, Dan, I think that the entire market knew that there would be a slowdown in demand as we came off of the tax credit.

I think it was widely talked about and expected.

It's just that the reality of it just doesn't feel good.

And I think we're getting a reaction to the way that it feels right now.

I think from our vantage point, we clearly thought that there would be a slowdown and expected that volume levels would be down.

So the answer to your question is yes, we are kind of where we expected to be.

And I think it will find its way back from here.

Okay, thanks very much.

Our next question is from Stephen East of Ticonderoga Securities.

Good morning.

If we look at orders in Houston and the West, they were down pretty sharply.

How much of that is a function of community count versus absorption rates?

And if it's absorption rates, what do you think's going on there?

Well, as I said earlier, Houston and Dallas were late to go into the decline.

Some of it is absorption pace, a fair amount of it is community count.

Looking up some hard numbers for you.

On a community count basis, we're somewhere in the 5% to 10% range down on a year-over-year basis.

So that's clearly having an impact.

Some of that is also skewed by the timing of when those come one.

So, it's a combination of the two.

Okay, similar in the West?

But, that being said, we are making money in Houston.

Okay.

Alright.

Similar in the West?

Similar in the West.

Okay.

If we look at -- you said -- Stuart, you said in this environment you could still make money.

Roughly where do you think is your breakeven volume?

And then the other question I had was just what you're seeing in the land environment?

We're hearing that some of the public builders are starting to back away from some land deals, et cetera, and just wanted to get a feel for what you all are seeing?

Just one clarification on the West.

On a community count basis, we're down about 15% to 20% in that area.

Okay.

Sorry.

And, you know, as it relates -- I'm going to, I'm going to let Bruce talk about the first part of your question.

But let me just say as it relates to some builders starting to back away from land deals, you know, there was a pretty good rush to buy land deals and to tie them up.

There were some that went in and tied up whatever they could and the pricing kind of made you scratch your head.

You had to see some real recovery going forward.

I think that some of those land deals, as people back away, will start making noise in the market.

But a lot of the -- certainly the land deals that we've done are not deals that we want to back away from.

We've, we focused on underwriting them to current market conditions with even some buffer, and we feel pretty good about what we've, what we've put under contract, and we're seeing some real results from some of those properties.

So I don't see us backing away from the deals that we've put under contract, but there are going to be some deals that get backed away from.

They just didn't make sense at the outset and that will create a little noise in the market.

Bruce, do you want to-- ?

Yes, your question on breakeven, Stephen, it's not a static environment.

What I would say as you go back in time, we were profitable as a Company at much lower volumes.

So it's really a function of what's driving lower volumes and our ability to react and either modify our product accordingly and depending on how much it drops down, make the appropriate SG&A adjustments as required.

So it's more, more a function of why.

But we've been profitable at much lower levels throughout our history, so we have the ability to adjust accordingly.

Sure, I understand.

And one other question.

On your community count, how much of that is reloaded land versus more historic land?

We have feathered in, started to feather in a couple of communities this quarter from [Mothbog] lands.

More of it is coming from new opportunities, though.

Okay.

Thanks.

On the land side, to give you a little bit more color, as we said over the last several quarters, we were relatively aggressive early on in contracting for some new deals on an option and also a cash basis.

If you look sequentially, I think last quarter we announced that we contracted for about 5000, plus or minus, new home sites during the quarter.

This quarter, we're about half of that.

And that's somewhat driven by the fact that pricing is up a little bit and we haven't been willing to shape the pricing up.

We're only doing deals that pencil out at a strong, respectable margin and IRR.

If some of the deals that some other folks were chasing at higher price points come back to where we think we should be appropriately priced, I think you'll see a little bit more activity going forward.

Regionally, do you see one area being more rational than the other on those, Rick?

Yes, but I really don't want to comment on this call about that.

Okay.

Thank you, guys.

Our next question is from Jade Romani of KBW.

Yes, hi, thank you very much.

I was wondering, can you tell us, does your impairment analysis account for the tax credit slowdown, related slowdown in May and also June, as you mentioned?

And is it possible that a temporary slowdown in absorption pace could trigger future impairments?

We run cash flows on our communities each quarter and it's based on the current environment that exists.

So we adjust that every quarter as we look at that.

So it does take into account the realtime activity that we've been seeing.

Okay.

And then secondly, just regarding your capital allocation and incremental investments, I was wondering if you could just give some color and to your thinking on how you plan -- or, how you expect to allocate capital between Rialto and new land investments?

You mentioned future high-return investment opportunities.

What kind of returns are you targeting in?

And in which areas do you think it's greatest?

Well, you know, we have two competing reservoirs fighting for capital right now and we like that position.

We're looking at every land deal and stressing it and expecting that if we're going to put money into a deal, it's going to have a solid return.

And it's competing for capital against the opportunities presented in the Rialto segment.

The Rialto segment, we know if we're going to win a bid, it's going to produce the outsized returns, and we want to be investing, we want to be investing a significant amount of capital in that business as opportunities present themselves.

So the answer to your question is it's a real balancing act.

To the extent that we have limited dollars, we're going to be investing those dollars where we can get the most sound return.

Let's remember that home building today is, is a cash generator by and large, with every home sold and delivered, we are generating cash to support acquisitions of new home sites, because part of the sales of the home is the land underneath it.

So, you know, there will be capital available just from the operations of the home building segment to support the purchase of new land, to the extent that we can find additional land that supports outsized returns, we'll be investing in that as well.

But we are allocating a lot of capital to our Rialto component right now because we see significant outsized returns coming from those investments.

Great, thanks very much.

Thank you, and I think we'll take one more.

Our next question comes from Megan McGrath of Barclays.

Great, thanks.

Just two questions.

The first, a follow-up to your question -- the questions around your community count and the pace that we're seeing right now.

Just trying to give a sense of -- in the short-term, let's say between now and the end of the year, how sensitive to this current pace are your plans to open those communities?

If we saw the slowdown persist steady into August that felt like it was beyond normal seasonal slowdown, would that impact your plans to open new communities for the end of the year?

Or is that -- are they sort of a longer-term, two-year, three-year plan?

Well, on the thing that we put under contractor bought, you know, I think the only thing that might be impacted by that is the pace of starts associated with that community.

With regard to opening a community, we want to get the models open.

There's some seasonality associated with that, depending on the market.

And as in the normal flow of business, we gear starts so sales tracks.

So I don't think it would impact the opening of the community.

It might just impact what the inventory levels are.

Let me just add to that and say that the new communities we've gone out and purchased have been really targeted to micro markets that we think are underserved, or really well positioned.

So, you know, I think it's important to keep in mind that when we see national numbers, those national numbers might be cutting an opposite way from a specific community.

We think that our newer communities have really targeted to the areas that are most likely to be able to sustain themselves even as the market might pull back a little bit.

So we expect to open all of the new communities in sequence as we're able to get them open.

Great, that's helpful.

And then, just a quick follow-up on traffic.

I think you mentioned some details around your traffic.

We heard from some other builders that after the tax credit, in addition to a decline in volume in traffic, the quality of the traffic was getting a little worse.

In other words, it was taking a little longer to translate those buyers into -- that traffic into an actual buyer.

Are you experiencing the same thing at the moment?

I think in the month of May, it was pretty sparse from traffic standpoint.

And, you know, all of the the, I guess the -- say it's the low hanging fruit was plucked off of the tree.

What we have seen in June, we have seen increased quality of traffic and that's a really good thing for us and for the industry.

It is market-specific.

But as you would expect, Gwen, when price points go down and affordability increases, you've got some people looking that real can't buy the home without getting money from some other folks to help pay for it.

So we're seeing a lot of that.

Great, thanks.

And I think this is a good place to conclude, because, look, as we look ahead and as we all monitor the market conditions that are here, as I've noted it in the past and I note it again today, this is going to be a rocky and sloppy bottom and stabilization process.

I think that, I think that it is natural that as we go from stimulus to free market conditions taking over responsibility for that stabilization process, it gets uncomfortable.

The handoff is not, is not an easy or a comfortable transition and I think that's where we are right now.

I think that there are reasons to be concerned about market conditions, but there are also reasons to see our way through to free market taking over and finding stability.

Consumer confidence is better, the economy is-- has been stabilizing, interest rates are low and home prices are down.

And we're looking forward to seeing this market stabilize as we go forward.

And with that, I'll say thank you, everybody, for joining us and we look forward to talking to you about our third quarter in just a few months.

This does conclude today's conference call.

Thank you for participating.