Lennar Corp (LEN) 2010 Q4 法說會逐字稿

Thank you for standing by, and welcome to Lennar's fourth quarter and year-end 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 is being recorded.

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

I will now turn the call over to Mr.

David Collins for the reading of the forward-looking statements.

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 operations, 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 like to turn the conference call over to your host, Mr.

Stuart Miller, President and CEO.

Sir, you may begin.

Good morning.

I'd like to thank everyone for joining us for our fourth quarter and 2010 year-end update.

We're very pleased to announce our fourth quarter and year-end results.

2010 marks a very solid year of performance for our Company against the backdrop of a very difficult economic and homebuilding environment.

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

Additionally, Jon Jaffe, our Chief Operating Officer, Rick Beckwitt, our Executive Vice President, and Jeff Krasnoff, Chief Executive Officer of our Rialto segment, are here and will be participating in our question-and-answer period.

I'm going to begin with some opening brief remarks about the current housing market in general and the progress that we've made on managing our business, and Bruce will provide additional detail on our numbers.

And then, of course, we're going to open the phones to your questions.

As always, I'd like to ask that in our Q&A period, everybody please limit it to just one question and one follow-up so that we can be as fair as possible to all of the participants.

Okay, our fourth quarter marks the end of what has been a complicated and difficult year in the housing market in general.

The year started with signs of stabilization and high hopes that the stimulus plan of a tax credit, together with historically low interest rates, would help form a foundation on which the housing market might form a comeback.

Unfortunately, as the tax credit expired, it became clear that it had only pulled existing demand forward, and the housing market slumped back into recession under the weight of shadow inventory and foreclosures.

Low interest rates alone were not enough to sustain higher demand levels and overcome high unemployment, low consumer confidence, and the customers' general inability to secure down payment funds.

The housing recession/depression that started some five years ago has left an indelible mark on the landscape of the housing market that will be with us for some time to come.

We continue to believe that the housing recovery will traverse a long and bumpy road that will be inconsistent and uneven from submarket to submarket.

Shadow inventory and foreclosures will continue to impact individual markets on the supply side, while the pace of recovery in the job market will influence consumer confidence and demand.

We've seen some early signs of gradual stabilization in the market.

MLS listings have declined in many of our markets, and the foreclosure pipeline, as measured by delinquency rates, has trended down.

Against this rather difficult backdrop, we are very pleased that our fourth quarter and year-end results represent a continuation of Lennar's return to profitability and represent solid operating performance in all areas of our Company, even while market conditions have not improved.

Overall, net earnings were $32 million, or $0.17 per share, for the fourth quarter, and $95 million, or $0.51 per share, for the year.

All three segments -- homebuilding, financial services, and Rialto, contributed to the Company's profitability, and we continue to look to overall profitability for the full year 2011.

Perhaps most importantly, aside from our return to profitability, we had many significant operating accomplishments in 2010 that will afford a significant operating leverage when market conditions do ultimately begin to improve.

On the homebuilding side, 2010 has been a year of basic blocking and tackling, as we focused on maximizing operational efficiency in order to achieve profitability, even in depressed market conditions.

In every one of our divisions, we've created new product that is desirable to today's market, while offering fewer plans and redesigning efficient plans that allow us to minimize costs.

We have used these efficient designs as a foundation to renegotiate costs and reduce our direct costs by an average of 25%, enabling us to achieve appropriate gross margins.

While some of these costs will rise as demand returns, and will be passed on through price increases, many of the cost efficiencies that have been incorporated will benefit our ongoing cost structure permanently.

Cycle times continue to come down due to our new, more efficient product.

We have simply never run more efficiently in the field, on both the building and the purchasing side of our business.

And given the very limited volume of construction nationally, our supply chain continues to work with us to lower our per-foot build cost.

At the same time, we've maintained inventory levels in our communities well balanced, with completed specs remaining at about one to two per community.

We are keeping our construction process tied very closely to our sales results.

Additionally, we've reignited our Everything's Included marketing platform, in order to ensure that Lennar homes always offer the very best value proposition in any of our markets.

Lennar's Everything's Included platform has always delivered the best value in our markets by targeting the options and upgrades that are most desirable to our customers and including them in the home offering, while eliminating options and upgrades and the overhead associated with them.

We've also right-sized our operations.

We have reduced our SG&A in each of our operating divisions, so that we are sized with appropriate personnel to operate profitably at today's depressed volumes, while maintaining our most talented associates, who will be able to help drive even greater earnings as market conditions do improve.

We are sized to be able to make money today, and to drive greater profit as the markets move forward.

Finally, and perhaps most importantly, we have continued to purchase new strategic communities in the very best locations and submarkets, and have used these community purchases to help drive gross margins higher.

We've been very selective to purchase only those communities that will drive our gross margins, and we have avoided the competitive bids that have resulted in driving land prices higher.

We have used our Rialto point of entry as an opportunity to access sellers and find and negotiate for land that is not yet on the market.

Overall, 2010 has been an excellent year of repositioning for our homebuilding operations, and we are well positioned to drive our bottom line when market conditions stabilize and improve.

In addition to our accomplishments in homebuilding in 2010, we also successfully completed the creation and launch of our new business segment, Rialto.

While we began the process of preparing the launch of this business segment some three years ago, 2010 saw the investment of approximately $500 million in various assets that would utilize the Rialto machine.

Rialto immediately began returning profits on those investments, and is very well positioned to continue to invest capital and generate outsize returns on that invested capital.

In our Rialto segment, we purchase large and small portfolios of loans and REO at wholesale prices, and then work through those assets one at a time to resolve at retail payoff.

It's all about making money by managing the process of purchasing wholesale and selling retail.

Purchasing in bulk, selling one at a time.

Admittedly, the assets are a little bit more complex, but this is where we are expert.

The major contributors to Rialto's $12.4 million of operating earnings in the fourth quarter are -- our share of the profits from distressed real estate portfolio transactions, our public/private investment fund activities with AllianceBernstein and the US Department of Treasury or PPIP, and the fees that we receive from others for our management of these investments.

As indicated in our press release, we had a busy quarter adding to the distressed investments portfolio, with the acquisition of approximately $740 million of real estate assets from three large financial institutions.

The combined portfolios added almost 400 loans to the over 5,500 we had previously acquired in partnership with the FDIC.

All told, during fiscal 2010 we acquired loans with an unpaid balance of approximately $3.6 billion, as well as over 300 real estate properties that the sellers had appraised at over $200 million.

With unpaid accrued and default interest and other amounts due from borrowers, the total is approximately $4.5 billion that we acquired for approximately (inaudible due to loss of audio) billion, or $0.33 on the dollar.

And our net investment equaled approximately $430 million, after accounting for seller financing and the FDIC's equity interest in our first two portfolios.

We also completed the first closing of the Rialto real estate fund, with investors committing approximately $300 million, of which $75 million will come from Lennar.

The fund's objective is to invest in distressed real estate assets and other related investments, similar to what we have already been doing.

And just a couple of weeks ago, actually New Year's Eve, we closed on the fund's first investment, a $34 million portfolio of non-performing loans.

On the operations side, we continue to build an outstanding team of professionals at Rialto, on our strong base of already familiar faces.

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

The Rialto team is now well over 110 associates, focused on portfolio operations that include loan workout, property asset management, servicing, finance, and back-office operations in our three main offices in Miami, Atlanta, and New York, along with a growing number of satellite offices located in Lennar's homebuilding offices, such as Southern California, Phoenix, and Las Vegas.

Our disciplined loan workout and resolution process are initially -- were initially designed almost two decades ago to maximize proceeds and returns from distressed assets.

In our weekly asset manager meetings, our team methodically and professionally approaches and deals with the underlying borrowers, and tees up many of the resolutions that have to date exceeded our initial underwriting.

We are now deep into all of our 2010 portfolios, having had contact with borrowers representing over 90% of the combined outstanding loan balances.

And in our first two transactions with the FDIC, for which we took over management some nine months ago, we have now fully resolved over 240 assets and have brought in over $190 million in cash, with our team achieving an average resolution of some $0.90 on the dollar, though it's still early in the game.

Over half of these results -- resolved assets have been at levels at or higher than the full outstanding amount of principal due on the loan, because we have been able to collect past-due accrued interest and late fees.

We now have over $175 million of cash on the partnership balance sheet.

Over $120 million of this is earmarked to [defease] the original $627 million of acquisition financing, and the rest is available as working capital to help us maximize the resolution of the remaining assets.

We believe that our teams and the infrastructure we have in place today is ahead of the pack and is setting the standards for best practices in the industry.

This has positioned us extremely well for a growing pipeline of opportunity from the FDIC, from banks, and from others.

Our due diligence team has been evaluating billions of dollars of potential opportunities.

But our team distinguishes itself, because it is made up of already in place managers who are today working out loans and dealing with similar underlying collateral in the same markets, and in a number of cases, the same borrowers.

If we're able to purchase assets at our pricing, and we believe we will, we are positioned to quickly and efficiently bring those assets right into our already in place workout machine and maximize bottom-line profitability.

And because of the high percentage of loans made to developers, being able to efficiently incorporate Lennar's homebuilding unique view and expertise gives this segment another distinct advantage in our evaluation and maximization of value for the assets.

As a Company, we remain very excited about our Rialto position and our marketplace, and we look forward to reporting to you on the progress -- on our progress in future quarters.

Overall, in the context of a very difficult market, we are very pleased with the progress we have been able to make, as reflected in our fourth quarter and our year-end 2010 results.

And more importantly, we're very excited about the general direction of our Company's strategy.

Homebuilding and financial services remain positioned to be profitable in today's uncertain times, and to drive materially improved profitability as the market stabilizes and ultimately begins to recover.

At the same time, our Rialto strategy is building momentum in this distressed environment, as it grows both new and exciting opportunities to invest Company capital and, as well, produce real bottom-line profitability.

Our people continue to be a bright spot in the Company.

The dedication and focus in all parts of our Company are a true source of pride.

From the execution of business plans in the field, to the cooperative spirit that exists between the Lennar homebuilding segment and the Rialto segment of our Company in sourcing new business and opportunities, our people are really making the difference.

More importantly, our in-place management team and overall staffing are positioned to drive real operating leverage, as market conditions continue to improve -- or as market conditions improve, and they will.

With the people now in place, we are positioned to be able to drive substantially more homebuilding volume and substantially more Rialto investment, without adding overhead.

While we remain cautious about the immediate future, we do believe that we have properly positioned the Company to succeed in the current environment and to excel when the market recovers.

We will continue to make strategic and opportunistic investments and focus on every aspect of cost structure as we look forward to a profitable 2011.

Thank you.

Thank you, Stuart, and good morning.

This was another quarter of positive operating earning contributions from all three of our business segments.

Our homebuilding business improved significantly, as noted by operating earnings of $27 million this quarter, compared to a loss of $277 million last year.

Revenues from home sales decreased 13% to $726 million, due to a 12% decrease in home deliveries, excluding joint ventures.

While the Company's average sales price was flat year-over-year at $238,000, the regional average sales prices were also relatively flat, except for our Houston homebuilding segment, where the average sales price increased 9% year-over-year.

Our preimpairment gross margin improved to 20.8%, versus 17.8% in the prior year.

Gross margins were strongest in our East Region this quarter.

And the improvement in gross margin is due to a combination of deliveries from new communities with higher gross margins, continued focus on controlling costs, and a reduction in sales incentives on homes closed.

Sales incentives declined from $36,300 per home to $33,700 per home during the quarter.

And this is a reduction from 13.2% of home sales to 12.4% of home sales.

As we indicated on our third quarter conference call, we expected that the fourth quarter would have approximately a $2,000 to $5,000 sequential increase in sales incentives, and the actual increase was approximately $3,100 per home.

Homebuilding community impairments decreased to $22.3 million, compared with $55.5 million in the prior year.

And the impairments during the quarter were primarily a result of a strategy to reduce prices and increase absorption in several communities.

Our selling, general, and administration expenses, as a percentage of revenue from home sales, was 14.1%, and that was a 210 basis point improvement from the prior year.

The improvement continues to be primarily in the areas of lower expenses in the legal, personnel, and occupancy categories.

Our improved gross margins and reduced SG&A led to another quarter of improved operating margins, increasing 510 basis points from the prior year to 6.7%, which is pre-impairment.

Gross profits on land sales totaled $13.7 million, and that was primarily due to the recognition of a deferred revenue related to a profit participation agreement.

Our financial services business segment generated operating earnings of $11.7 million, and that is compared to $7.8 million profit from the prior year.

This is primarily due to higher volume and profits per loan in our mortgage operations.

Mortgage pretax income was $11.1 million, versus $7.9 million in the prior year.

And many of you have been asking about our mortgage putback exposure, which we have indicated is not material.

At the end of the fiscal 2010, our reserve for mortgage putback settlements was $9.9 million, and that compares to $9.5 million in the prior year.

Our title company was profitable.

It earned a $1 million profit for the quarter, versus $2.3 million in the prior year.

Our Rialto business segment also generated operating earnings, as Stuart mentioned, totaling $12.4 million, and this number is net of $12.7 million of net earnings attributable to non-controlling interest.

As a reminder, we consolidate the FDIC portfolios, and therefore, our results reflect all the activity from the FDIC entities, with an offset attributable to non-controlling interest.

I'd like to simplify Rialto results for you, so I'm going to give you a summary of Rialto's $12.4 million of operating earnings by type of investment.

There was $10.6 million of earnings generated from our 40% share of the FDIC portfolios during the quarter, $7.4 million relating to PPIP, $3 million relating to the bank loan portfolios acquired during the fourth quarter, and then there was approximately $8.6 million of G&A and other expenses.

The $10.6 million of earnings from the FDIC portfolios includes income from -- first, accretable interest income, based on the expected cash flows from loan payoffs and interest income, second, gains from sales of real estate owned, third, gains upon foreclosure of real estate owned.

When an asset is foreclosed upon, there is a fair value performed on the asset, which can result in a gain or loss.

And then, fourth, fees for managing the FDIC entity.

G&A expenses were $8.6 million.

However, we earned approximately $4.3 million in gross management fees that were in the performance of the fore-mentioned investments.

The $3 million of income generated from the bank loan portfolios is primarily from accretable interest income, and the $7.4 million of earnings during the quarter from our investment in PPIP is reported as equity and earnings from unconsolidated entities.

$2.7 million of this income is interest income, and $4.7 million is due to unrealized gains.

The G&A and other expenses in the Rialto segment include G&A costs and expensed underwriting costs for new opportunities.

Corporate G&A expenses were reduced by $7.7 million in the quarter, or 24% versus the prior year, as a result of our continued focus on cost-reduction initiatives.

We were successful in finding another opportunity to recover funds related to our expenses with Chinese drywall, as we utilized the 10-year product liability carryback, which is included in this quarter's tax benefit.

In the fourth quarter, we continued to maintain balance sheet strength while investing in new strategic opportunities.

Our liquidity is strong, our leverage remains low, as our homebuilding debt to total capital, net of the $1.2 billion of cash, was 42.4% in the fourth quarter.

Shareholders' equity increased to $2.6 billion during the quarter.

And our leverage ratio will improve further upon the full reversal of the $609 million deferred tax asset, which we still expect to occur in 2011.

Additionally, we retired approximately $109 million of Lennar debt during the quarter and issued $446 million in a new senior convertible debt offering during the quarter, which has a 2.75% coupon and a 40% conversion premium.

We replaced our cash collateralized letter of credit facility with a $150 million, three-year unsecured LC facility with five banks.

This released approximately $150 million of cash that can now be put to work in new investment opportunities.

We continued our success in reducing our joint ventures.

This quarter was reduced by six, and unconsolidated JVs are now 42, and only 14 of those have recourse debt.

Additionally, we reduced our maximum recourse indebtedness to $173 million at the end of the fourth quarter, and the remaining unconsolidated JVs with debt are conservatively financed with an aggregate net debt to total capital of 36%.

Our inventory is well-positioned as we enter 2011.

We invested $84 million in new, well-located communities in the quarter, totaling approximately 2,500 home sites.

Inventory decreased approximately $100 million sequentially to $3.7 billion, and that includes -- that excludes consolidated inventory not owned.

There were 84,000 home sites owned, 20,000 controlled, totaling 104,000 at the end of the quarter.

We ended the quarter with approximately 1,000 completed unsold homes, and with 440 active communities at the end of the quarter, it's just a little above two per community.

We started 1,800 homes during the quarter.

And we entered fiscal 2010 expecting to return to profitability for the year.

We completed 2010 earning $95 million of net income for the year.

Similar to 2010, we expect profitability in our first quarter of 2011 to be challenged, based on a low volume of projected Q1 deliveries.

However, we are confident that 2011 will be another profitable year.

Let me turn it over for Q&A now.

We will now begin our formal question-and-answer session.

(Operator Instructions).

The first question comes from Ivy Zelman, Zelman & Associates.

Your line is open.

Thanks.

Good morning, guys.

Congratulations on a great quarter.

My first question pertains to your new communities with respect to going forward.

You ended the year at 440 active communities, recognizing you might not have a definitive number, but you expected to be north of 10% growth in communities.

And, within the communities that you did operate in the fourth quarter, what percent of the closings or orders, however you want to frame it, Bruce, came from new acquired lots at distressed prices, that would obviously be higher margin, roughly?

That's the first question.

I do get a follow-up.

Well, let me answer the deliveries in the fourth quarter.

We took a look at that, and about 10% of the deliveries came from some of the new communities acquired over the last four to six quarters.

And relative to the community count, we ended at 440 for the year.

And, maybe Rick or Jon, you want to take where we're headed as far as communities?

Well, if you look at the last quarter, Ivy, we probably brought on about 29 communities during the quarter.

Not all of them are open yet in traditional community count, but those are basically the deals that we did as a Company, coast to coast.

I think that it would -- it's going to depend on the quality of the deal.

Our underwriting standards are extremely tight today.

As we'd said in the past, we don't incorporate in any inflation or underwriting needs to north of the 20% gross margin, 20% IRR, and targeting a minimum of about a 10% pretax.

So every deal will be additive.

I think it would be safe to assume that we're probably going to add another 10% to 15% in 2011.

Let me just add, Ivy, and say that as we look at the communities that we've brought on, and the ones that are coming on, all of our new communities are in fact accretive to our gross margin.

So, we're seeing some real positive impact from some of the communities that are being brought on, even while our existing communities are faring pretty well, as well.

That's great news.

I guess, just a follow-up question relating to the underlying demand, and looking at your fourth quarter with you permanently reducing your cost structure, and therefore showing better profitability.

Everyone is wondering, is it sustainable in an environment in 2011 that arguably could be pretty still tenuous demand on the demand side.

And recognizing that you did better on orders than I think the market was looking for, and some of your peers, it looks as if your incentives didn't really see a big increase.

So, I guess with respect to 2011, if demand was to remain where it is today at pretty low levels, do you think that the sustainability of the margins are there?

And do you see any bright signs or any traffic underlying demand characteristics that might give us some hope?

I know that KB Homes indicated they were seeing more stringent underwriting.

So, a little of your thoughts, Stuart, just on demand, and as you mentioned, you expect to be profitable in 2011.

So does that mean you are not expecting an improvement in demand, and holding at the current levels in order to drive that profitability in 2011?

Listen, I've said many times, I think it's hard to look past just the month that is ahead of us in a market like this.

And I think that there are some mixed signals out there.

As we project and as we look forward, we are not anticipating improvement.

But with that said, we are seeing some indicators of some stabilization in the marketplace.

That's not to suggest that it is stabilizing, and it will start to recover, because I just don't know.

But the indicators that we're seeing, and we just had our division Presidents meeting that we do on a quarterly basis.

And in almost every single market, the indicator from the field is that MLS listings are down, the backlog of foreclosures, as indicated by delinquency rates, seems to be trending down, and these would be good signs for future improvement or at least stabilization.

As we're looking at our performance for 2011, we're not anticipating improvement in the marketplace.

We think that we can remain profitable, with solid gross margins.

It doesn't mean that they won't be somewhat challenged, if market conditions remain challenging.

But we think that we're going to be able to maintain our current profitability through 2011, even at current levels.

And that's what we've designed our Company position to be able to do, is to remain profitable in these conditions, even with some negative bias, and to really be able to leverage that overhead as we go forward.

And let me just say parenthetically, that as market conditions continue to remain stagnant, this all augurs in favor of our Rialto program, and affords us even more opportunity to invest in distressed, and leverage that operation.

So, we think that we have a balanced and intelligent program that's positioned for profitability, even at current levels, with a negative bias.

And we think any improvement in the marketplace really works well for us.

One thing I would add, Ivy, is with regards to margins specifically.

As Bruce shared with you, on a current delivery basis, the new deals are really not adding a lot to our bottom line and our gross composition.

And as the year moves forward, we're going to get some upside benefit associated with the mix of new communities coming in, because they were purchased very, very attractively.

On the offset to that, we do anticipate, as the market improves, that there will be some cost increases associated with material costs.

And that is something we can't control.

Commodities will move one way or another.

The trades are going to try to improve -- increase pricing, and we're going to have to deal with that.

And if the market does recover well, we'll be able to pass some of that on to the consumer.

The things that should maintain with regard to true benefit of the bottom line are all the redesigned, re-engineering, restructuring things of our baseline product that we pulled out real hard costs out of the home from a construction and build costs standpoint.

So, from a sales standpoint, we're pricing to sell in the market.

If the market is at $100,000, that's where that price of that home should be, we're going to sell it at that price.

We do know how many homes we need to sell in a current community in order to have that community have a pretax positive disposition.

We look at everything on an individual profit center, and margins will move up and down during the year.

But we're positioned right now to make money in 2011.

Thanks, Rick.

Just wondering about the underwriting, any changes that you saw during the quarter with respect to the mortgage tightening or any comment there, please?

Mortgage underwriting has gotten a bit tougher.

We've seen the underwriting standards get tighter.

Bruce, you want to talk about that at all, or Jon?

Hi, Ivy, it's Jon.

We have definitely seen a difficulty in getting desired buyers qualified through the process.

And from what we see at the field level, this is creating more of a pent-up demand, as it seems like there is an interest in buyers, but difficulty getting them actually approved in the closing table.

I would say, related to -- .

I'm sorry to interrupt, it's not the mortgage rate per se going up, it's more just getting the credit approved, or whatever the stringent underwriting standards may be.

But the traffic is there, and there seems to be demand, it's just the tougher underwriting standards, not the rate itself?

It's really -- we're seeing plenty of demand, Ivy.

Standards have gotten tighter.

We're seeing some benefit from improving appraisals as we move across the country.

And I think you've asked enough of your questions.

We need to move on.

Nice try.

Thanks.

The next question is coming from Jonathan Ellis, Bank of America Merrill Lynch.

Your line is open.

Thank you.

First question, just on gross margins.

If we look at the fourth quarter, can you help us understand, if I heard you correctly, there was some benefit from Chinese drywall recovery?

Could you, if possible, quantify that?

And then also, was there any difference in the mix of spec sales in the fourth quarter, vis-a-vis the third quarter?

Well, let me talk to the gross margin, Jon.

There was no benefit in the fourth quarter from Chinese drywall.

In the third quarter, we had some benefit from recoveries.

But in this quarter we just reported, there was no positive benefit relating to Chinese drywall.

And the Chinese drywall accruals that we made are adequate, and there is opportunity for third-party recoveries that we're still working on that could help future quarters.

But there was not anything in the fourth quarter.

And then, relative to spec sales, compared to another quarter, there really wasn't a significant difference in this quarter compared to past quarters.

Okay, great.

And then, just in terms of your community growth for next year, do you anticipate that based on what you've been able to acquire thus far, that the community count increase could be concentrated in certain regions more so than others, such that it may have an influence on your delivery pricing next year, just based on geographic mix?

From a regional standpoint, we have -- the composition of the things that we've put under contract has varied quarter to quarter.

And from our perspective, we're investing the capital where the best opportunities are, not geographically.

So, if that means we are doing a deal in Raleigh versus in Denver, that's what we are going to do.

Yes, as I've noted many times, we are very submarket specific, micro-market.

And it's really a question of where we'd find submarkets that are outperforming the norm, that's where we're investing capital.

It can be in California, it can be in Raleigh or Florida.

It's more about the submarket.

Okay.

Thanks, guys.

The next question is coming from Michael Rehaut, JP Morgan Chase.

Your line is open.

Thanks.

Good morning, everyone.

My first question, just to go back to the gross margins, I guess the incentives went up, you said about $1,300 per home, which was much less than what you had been looking for.

I was wondering if you could just drill down a little bit into the drivers of that, be it mix or just perhaps a better overall or less competitive environment than you might have feared, just in terms of the actual versus expected?

Let me just clarify the numbers, Mike.

So we had estimated in the last quarter conference call that our sales incentives would increase $2,000 to $5,000 per home, and the actual increase was $3,100, (technical difficulty) mid-point.

So it was very much within our expectations during the quarter.

So, our success, again, in the quarter, as we indicated, is the combination of deliveries from new communities with high margins, our focus on controlling costs, and then, on a year-over-year basis, was the reduction in sales incentives with the prior year.

Okay.

I guess I misheard that, and miffed my first question.

But maybe I could make it up with the second.

On orders, still getting a lot of positive benefits in the east, and I assume a lot of that is coming from the assets that you purchased from Starwood, and then how those communities are working out.

At the same time, the west and Houston continue to be drags.

And I was wondering if, what we can expect over the next 12 months in those regions, if you have some community count growth, or expect some stabilization in those regions, or perhaps growing off of the lower base that you're at right now?

This is Jon.

I think consistent with the prior answers, it's very submarket specific.

And we are finding opportunities in Houston and in the west markets, in particular communities to acquire new assets that meet our underwriting standards of 20% plus gross margin, and 20% IRR.

So, it will be driven by those opportunities as they come up.

And expect probably about the same level of activity, but it will just depend on how those markets perform.

Okay.

One last quick one, if I could.

Pricing trends, given that the higher incentives were roughly in line with your outlook, are you seeing any surprises?

Most -- KB had said that they still feel comfortable with some pricing discipline in the market.

Are you seeing similar -- you have similar observations across the different regions?

Well, this is preseason right now, from the standpoint of just typically where you sell a lot of homes.

I think that December and January will maybe be a more tougher pricing environment, but as the year moves through with increased traffic, pricing should get a little bit better.

But notwithstanding that, we're priced in the marketplace in all of our communities to sell.

And we're building under that cost structure.

All right.

Thanks.

Our next question is coming from Carl Reichardt, Wells Fargo Securities.

Your line is open.

Hi, guys, how are you?

I have a question about the 25% decline in directs that you mentioned, Stuart.

Is that on a per-foot basis, and how much of that decline would you attribute to better supply chain buying materials, costs, versus [despec-ing] the house, versus efficient construction?

I'm just trying to get a sense of how much that is sustainable going forward.

This is Jon.

There's been a focus on several levels in the Company.

I would say probably the biggest percentage goes to our national purchasing efforts, which is -- works hand in hand with our divisions, Carl, so that it's a combination of the efficient designs, working then at a national level on our item master, item by item, to bring costs down.

So, those two elements combined are probably the largest portion of it.

And then, market by market we've introduced cost-engineered efficient designs, as we said, easy and quick to build, that probably account for, I would say maybe 25% of that cost savings.

And the majority of it being more on the -- that meshing of national purchasing with the actual design, and working with the trades.

Okay.

Carl, let me just add to that and say, look, a portion of our cost reductions -- and they've been substantial, and it's been the result of a tremendous amount of focus, particularly on Jon's part, is attributable to market conditions, working the supply chain and the like.

But there is a sizable portion of these reductions that are structural in nature.

We've disentangled the purchase of labor and materials across the board.

We've gotten our hands around specific material costs, and we're buying more directly.

We have a national purchasing program that has bred consistency across the country for us.

So, we feel good about the cost reductions as it relates to current market conditions, and driving gross margins in current market conditions.

But we're perhaps even more optimistic about the permanent portion of those cost savings that will impact our margins positively as market conditions -- even as market conditions recover.

Okay.

Thanks, Stuart.

And my second and last question.

Of the $84 million you spent on home sites, 2,100 home sites, did any of that come through Rialto, and if so, how much?

Of the $84 million that we spent, Carl, on home sites, it was actually 2,500 home sites that we purchased.

And just a small number, a little less than 10% of that, the purchases came through relationships through Rialto.

Terrific.

Thanks, guys.

The next question is coming from David Goldberg, UBS.

Your line is open.

Good morning, everybody.

Morning.

First question, Stuart, good to hear some more conversation about Everything's Included.

I feel like it's been a little bit of a while since it's been talked about on the call, and kind of focused on.

And I'm wondering if you can talk, if there has been any changes in the way that you guys execute the EI program?

And then with that, how you measure the success of Everything's Included, in terms of generating demand relative to a more option-driven or more customization-driven model in the market?

Look, we've always felt that a solid Everything's Included program, with a lot of concentration on including options and upgrades that are the primary focus of our customers, is the best way to drive value and to keep overhead low.

And that's what our Everything's Included program has done.

I guess modifications that we've made to the program, it's kind of an interesting dynamic here, there is somewhat of a tug between Jon and Rick.

Jon, the purist on Everything's Included, and Rick, some modifications for today's current environment.

We have created some spec-level packages that enable our customers to kind of broadly change the spec level of their home in many of our communities.

But by and large, we have maintained a very low overhead structure in appealing to our customers on an Everything's Included basis, while affording them the opportunity to alter the spec level of their home in a packaged format.

It just keeps our program very efficient, and simple to operate.

This is Jon.

I would just add to that, that we continue to hear from our customers that they really appreciate the ease of the process of purchasing an Everything's Included home, and the value associated with that.

And as Stuart said, we really have, for this marketplace, designed it so that the packages are affordable and available to every customer type and desire.

Yes, good, better and best packages.

But everything's included in the package.

And then, if I could just get one more quick one in here.

Bruce, just to make sure I understand, I know you said first quarter profitability might be pressured a little, and it might be more challenging to be profitable.

Would that change your expectations for reversing the deferred tax asset allowance at all, if you guys did lose money in the first quarter from an operating perspective?

It doesn't change my expectations.

As we've said all along, the auditors (inaudible) national office.

But I don't think one quarter, because of low volume, where we have positive operating margins, will be a change to the trend that we're on to be able to reverse the DTA reserve.

Great.

Thank you very much.

The next question is coming from Josh Levin, Citigroup.

Your line is open.

Thanks, good morning, everybody.

When mortgage rates increased rapidly in December, did you notice any changes in traffic and sales patterns in your communities?

Did it have a negative effect, or did it have a positive effect?

Create a sense of urgency?

This is Jon.

No, we really didn't see an impact.

The traffic patterns, we didn't see what you sometimes historically have seen, where rising rates might cause some people to get off the fence either.

It just seemed to be a continuation of the existing market conditions.

Part of that might be just because of it occurring during the holiday season and the end of the year, where things tend to be a little bit muted in terms of demand anyway.

But bottom line is, we really didn't see an impact one way or the other.

Okay.

And second question.

In the second half of 2010, I think many of the home builders said that they were not going to materially lower prices or increase incentives, because they saw that demand was inelastic, and it just wouldn't make a difference.

All it would do is take away margin.

So now we're looking toward the spring, the spring selling season starts in a few weeks.

And how do you think about the pricing strategy going into spring?

If it turns out to be a lackluster spring, is there a point at which you start to lower prices or increase incentives in a meaningful way, or is that just not going to move the needle?

I think that within our environment, pricing is a daily function.

We stay very, very close to the market at the division and regional level.

Our pricing is very reflective of what's happening in the market at a given moment in time.

To superimpose kind of a macro view, as we look ahead to the spring and spring selling season, would be getting way ahead of ourselves.

It's going to be very micro-market specific.

And while it might roll up to an overall trend, I'm not so sure that the trend will be reflective of anything important.

It's micro-market by micro-market, pricing every day and every week, discussions between the sales group, division President, and regional President.

We're very focused on pricing, and keeping it reflective of the existing market conditions.

And more importantly, our production pace, our start pace, is really geared towards the current traffic that we're seeing today.

So to the extent traffic picks up with a rebound of buyers in the market, then we'll modestly increase our production pace.

But it really shouldn't have that dramatic of effect on pricing.

Thank you very much.

Our next question is coming from Stephen East, Ticonderoga Securities.

Your line is open.

Thank you.

Good morning.

Just to follow on Josh's question a little bit.

Last quarter you were very clear about where your incentives were going, that they were going up, and you were going to move some product.

Now you're much more circumspect about what's going on.

Is that more a function of the market, or are you more comfortable with where your spec level is?

Is it more internal versus external?

Steve, I think that as we went into -- as we came out of the third quarter and went into the fourth, we recognized that we were going into the real soft spot of the year.

And we could really see that the trend was negative, and was somewhat mired in a combination of market trend and the seasonality that is overall generally negative.

We're now coming out of the fourth quarter and into the first, and I think that we are less pessimistic.

And I wouldn't paint an optimistic picture, but I'd say that the market condition is what it is, we're not going into the negative but instead to the positive side of seasonality, and we'd like to wait and see how the market presents itself.

We're certainly not anticipating moves upwards.

We generally have a negative bias, but we're not anticipating right now further erosion of gross margin or further incentive programs.

Okay.

That's very helpful.

And then, just switching to land, two quick questions on there.

One, what do you expect the land spend for 2011?

And then the second thing, you had deferred revenues in land sales.

Is that a one-time event, or is that something that is going to continue, and you all can give us some guidance on?

Steve, as far as land spend, if you were just to look at the land that came out through cost of sales, it's been in the $500 million to $600 million that's been coming out.

And we expect that to increase as we find opportunities next year.

So, we'll be north of that $500 million to $600 million mark that came out of deliveries this year.

And depending on what growth rate we find, and that's dependent on market conditions, that number will go up from there.

But our balance sheet is liquid.

We're focusing on a lot of interesting opportunities, and if we could bring those to conclusion, we'll grow beyond what's coming out of cost of sales.

Okay.

And then, on the deferred -- ?

On the deferred, every quarter there are some items that aren't expected one way or the other.

We didn't expect, if you added up all of the charges, there was $27 million of impairments between homebuilding, some write-off of deposits, and the like.

So, as you look at the $13 million of land sale profit, there were some other charges that were write-off of deposits and the like.

So, I look at that whole group as something that we don't project.

So, the deferred revenue for that one particular item doesn't recur, and I would hope some of the charges that we took this quarter don't recur either.

Okay.

Thanks.

The next question is coming from Jade Rahmani of KBW.

Your line is open.

Yes, hi.

Thanks for taking the question.

I just wanted to ask, on Rialto, how you would characterize the investment climate today, versus say, one to two quarters ago?

Are you seeing pricing becoming more favorable to the banks, and banks being more realistic on valuation and price expectations?

And then secondly, on CNBS, some trade publications have indicated Rialto has been an active buyer of B notes in new securitizations.

Do you look at this as flow of business?

And if new CNBS originations were to hit, say, $50 billion this year, how much capital would you allocate to the CNBS sector?

Thank you.

Yes, in terms of your first -- this is Jeff Krasnoff, by the way.

In terms of your first question, we are seeing, and we anticipated that we were going to see this happen after the FDIC sort of kick-started the market.

We have seen significant activity from a lot of the banks.

And I think that particularly the regional banks have had an opportunity, number one, to earn their way out of some their issues, raise new capital, and so on and so forth.

So, we are seeing a lot more realistic approaches from these institutions about selling assets.

And obviously, you can see that we've been -- we were involved this past quarter in three deals with regional banks, as well as we did that one small deal in the fund, as Stuart mentioned, right at New Year's.

So, we feel that the climate there is kind of reaching a very nice point for us, particularly considering the infrastructure we already have in, and the access that we have to a number of these institutions.

Let me add, look, we've seen increased activity in terms of the availability of product in the marketplace, and bids and negotiations to buying assets.

We think that the timing of closing our fund is particularly opportune.

The additional capital to be invested in the distressed market will be welcomed with a good deal flow.

We're currently underwriting literally billions of dollars of additional asset purchases, which we've incorporated a very disciplined program of underwriting and bidding and negotiating for prices that we're comfortable with.

We're very comfortable that we'll be able to fill the bucket, continue investing going forward.

As it relates to the CNBS market, we've most certainly put our toe back in the water relative to CNBS.

It has been reported, we have noted that we have bought a couple of unrated deals.

This, again, is an area that we are very comfortable with, and we developed tremendous expertise through the 1990s and 2000s building a business.

It is directly related to the primary Rialto business.

Right now, the amount of money that we're committing to that business is very limited.

And it is, again, invested dollars that will produce outsized return.

Thanks very much.

And then, secondly, just on the fund, can you just give some insight into how you choose between -- choosing to raise fund capital or deploy fund capital versus Lennar's own capital?

Thank you.

Yes, well, we recognized that the capital would be limited for an opportunity set that was very large, and would continue at least through the next year or two, present itself as an arena in which we want to invest, and could produce exciting returns.

So we felt that it was a good time for us to access the private capital markets, to augment the dollars that Lennar would be investing.

The dollars that we've invested to date, Lennar's dollars, will remain as Lennar's investment.

It is new investments that will be invested through the fund.

And as noted, Lennar is invested in the fund, and will have the opportunity to co-invest as we go forward.

We think that the fund gives us the maximum in flexibility in terms of being able to invest Lennar's capital, and being able to deploy Lennar's (inaudible), and Rialto's machine to be able to continue to produce outsized return.

And it's also a way for us to enhance our returns, because of the incentives that are built into the fund, in terms of the incentive fees, and so on -- or the (inaudible).

And with that, let's take one more question.

The last question is coming from Dan Oppenheim, Credit Suisse.

Your line is open.

Thanks very much.

I was wondering if you can talk a little bit about the El Toro restructuring, and how are you looking at that, and what has happened in terms of the equity that you have in that, and any other joint ventures in terms of financing that you see over the course of the year?

This is Jon.

We're very excited about El Toro.

It's a great land position in one of the most desirable markets in the country.

And with this debt restructuring and partnership restructuring, we've really stabilized the capitalization of the project for the next seven plus years, which will give us the ability to monetize the assets.

So, as we sit today, we are really excited about that.

We just submitted the next level of maps to the city for entitlement just yesterday as a result of that restructuring, and we're moving forward.

Let me add to that and say that the El Toro restructuring is somewhat similar to the Newhall restructuring.

It really positions the Company well to be invested in a strategic asset in a long-term excellent market.

These restructurings have come with some pain.

In 2010, Jon added five years to his age, and the restructuring takes a tremendous amount of time and energy.

With it now done and complete, we are positioned to be invested in and involved in a really important strategic asset in Southern California.

And we're really enthusiastic about it.

I think that similarly, many of our joint ventures have been and continue to be restructured, and will ultimately benefit the Company going forward.

Over the past five years, we've taken a lot of pain on some of these ventures.

As we come out of 2010, we are getting better and better positioned to reap some benefits from some of those deals as we go forward.

Okay.

Thanks very much.

Okay.

Well, listen, thank you, everyone, for joining us for our 2010 update.

The year has been a solid year of repositioning for the Company.

We're not only positioned for profitability as we look ahead, but more importantly, we are positioned for operating leverage as the market ultimately finds a bottom and begins to recover.

Thank you for joining us.

This will concludes today's conference.

All parties may disconnect at this time.