Lennar Corp (LEN) 2011 Q2 法說會逐字稿

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

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

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

Today's conference call is being recorded.

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

I will now turn the call over to Mr.

David Collins, Director of Investor Relations, for the reading of the forward-looking statement.

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 day 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 introduce your speaker for today's call, Mr.

Stuart Miller, President and CEO.

Mr.

Miller, you may begin.

Great.

Thank you, and good morning, everyone.

Thanks for joining us for our second-quarter 2011 update.

As always, I am joined this morning by Bruce Gross, our Chief Financial Officer; Diane Bessette, our Vice President and Treasurer; and David Collins, who just read the statement, our Controller.

Additionally, Rick Beckwitt, our President; Jon Jaffe, our Chief Operating Officer; and Jeff Krasnoff, Chief Executive Officer of our Rialto segment, are here to participate as well.

I'm going to begin with some brief opening remarks about the current housing market in general.

Jon and Rick will discuss our home building operations.

Jeff will update on Rialto's progress, and Bruce will provide details on our numbers.

Then, of course, we will open our phone lines to questions.

As always, I would like to request that in our Q&A period, everybody please limit to just one question and one follow-up, so that we can be as fair as possible to everyone.

In the context of what continues to be a very challenging US housing market, we are pleased to report our fifth consecutive quarter of profitability as we continue to position our company for future success.

While it's now well documented that the expected spring selling season of 2011 simply did not materialize, it is beginning to feel like the worst days of the housing market are getting behind us.

Although sales pace and price are still under pressure, traffic trends have continued to improve and real, traditional, primary purchasers with a real desire to purchase, are showing up, recognizing that prices are low, recognizing that interest rates are low, and that this is an excellent time to purchase a home.

Make no mistake, stabilization and recovery will continue to be a slow and rocky process as traffic and desire have not yet translated into strong actual sales.

These are, though, the first signs that repair of the market is upon us.

Sales remain constrained by available financing and confidence.

Today's ultraconservative home finance environment has been a limiting factor in the normalization of demand and confidence for both new and existing homes.

But as lenders begin to lend again, to appropriate underwriting standards, and they will, demand will be unlocked; and in turn, increase sales and improved year-over-year comparisons, together with positive press, will create much-needed urgency and unlock consumer confidence in the housing sector.

At Lennar, we've just completed our second-quarter operations reviews with all of our division presidents.

We've gone through the operations and business plans of each of our divisions and reviewed the performance and position of each division and their respective market.

I find myself somewhat optimistic about the future of the housing market in general and for our business in particular.

In almost all of our divisions, we are finding that there are pockets of activity that are actually strong.

And across our markets, primary buyers are venturing out from a long, cold winter to consider purchasing.

While the overall landscape remains somewhat troubling from a short-term macroeconomic perspective, at Lennar, we remain profitable in the short term.

We have sharpened our focus on our core home building business, given the current economic conditions, while we position for an ultimate recovery.

Driving profitability, we have gotten a lot of components of our business working.

Our product research and reworked product offerings are working to complete -- to compete favorably with the existing home market and foreclosures.

Our dramatically reduced cycle time is working to enable less reliance on standing inventories for sale.

Our intense focus on driving construction costs lower is working to enable value-oriented sales prices.

Our low inventory approach to sales and starts is working to help maintain our industry-leading margins.

Our carefully managed overhead levels are working to drive comfortable net margin, even at reduced volumes.

Our Everything's Included marketing platform is working to highlight our value-oriented offerings to our customers.

Our strategic land purchases, leveraging our Rialto relationships, are working to position us with low-cost land to drive higher margins.

And most importantly, our extremely strong management team that has driven this company through the best and the worst of times is working day and night to stay a step ahead of market movements.

We confirmed in our operations reviews that the controls and strategies that we've put in place over the past difficult years are working very well to enable us to remain profitable even at reduced volumes.

Jon and Rick will review some of these elements of our home building operations that are succeeding.

Additionally, our Rialto program continues to complement our home building activity as it also adds to our overall profitability.

Rialto has continued to grow, and Jeff will update you on this progress in just a minute.

All in all, we're very comfortable with the position of our company.

We know that market conditions remain difficult.

We believe that our willingness to confront the reality of market conditions honestly and early has enabled our company to make the important and necessary adjustments to quickly pivot to profitability and to properly position for the future.

Let me turn over now to John.

Thank you, Stuart, and good morning.

We're very proud of the pre-impairment 19.9% gross margin and 5% operating margin we delivered in our second quarter.

I will speak to our company's strategy on maximizing revenues and our intense focus on managing direct costs and overhead.

On the revenue side, we're focused market by market on driving sales by zeroing in on today's home-buying consumers' wants and needs.

We deliver value by targeting the right product and features.

Each of our divisions has redesigned floor plans, square footages and features to address today's customer profile.

Additionally, as Stuart has noted today and in past calls, we have reignited at Lennar's Everything's Included platform to highlight the energy-efficient, technological, and quality features that clearly differentiate our new homes as compared to the resale homes on the market.

In the area of energy efficiency, which is a real differentiator when compared to used and foreclosed homes, we are designing our homes to save customers around $1,000 per year on their electric bill compared to the typical existing home.

In some of our markets, we have homeowners who experience monthly electric bills that average below $10.

We're also including home automation technology that allows our homeowners to control door locks, lighting, thermostats, cameras, and more through their smartphone, iPad, or computer.

These today's technology features allow homeowners to enjoy their home in a way that previously either wasn't available or was too expensive for them.

We believe this strategy is allowing us to maximize our sales and sales price by giving customers a reason to buy in the current difficult market environment.

On the cost side of the margin equation, and at the same time as we are executing our Everything's Included strategy to include more features that appeal to today's customer, we continue to drive down the direct cost of construction.

Our current average direct cost of homes are approximately $40 per square foot.

This is down over 30% from the 2006 peak, and is a year-over-year reduction of over 5%.

We achieved this result through the hard work of extremely well-coordinated national and local purchasing teams that continually find answers on how to deliver more value for less.

We have also stayed focused on bringing down our cycle time, which is now down 27% from the peak.

This is accomplished by working hand-in-hand with our trade partners in designing and building more efficient, value-engineered homes.

This effort has allowed us to control our field costs, and effectively manage our inventory.

We have also maintained our intense management of SG&A.

As market headwinds result in downward pressure on home prices, we know that we have (technical difficulty) every day to reduce our cost structure.

Despite the cost associated with new community growth and today's overall lower absorption levels, our year-over-year SG&A spend for our second quarter was flat at $97 million.

At 14.9%, this represents a year-over-year increase of 100 basis points due to the decline in revenues of 6%.

To put our overhead focus into perspective, at the peak of the market in 2006, SG&A was $484 million compared to our Q2 2011 run rate of $97 million.

As Stuart mentioned, we have just completed our operations reviews with each of our home building divisions.

I can tell you that despite the reality of a disappointing spring sale season, we have a team that is energized to execute on the strategy of maximizing sales revenue and the goal of maintaining industry-leading operating margins through the active management of reducing cost of sales.

Thank you.

I'd now like to turn it over to Rick.

Thanks, Jon.

During the quarter, we continued to focus on acquiring or optioning new home sites that would have a positive impact on our bottom line.

We signed 25 new deal to purchase approximately 2900 home sites.

About half of these deals were option contracts where we put up a small deposit and have a right to take down the land over time.

The remaining deals were cash purchases or distressed loan purchases where we subsequently foreclosed on the land.

Our land spend during the quarter was approximately $109 million, down about $50 million from the first quarter.

At the end of the quarter, we owned or controlled approximately 108,000 home sites.

All of these new deals in the quarter were underwritten with extremely conservative underwriting assumptions.

They assumed no price increases and in some cases, price declines, slower declining sales paces, and were priced to yield gross margins and IRRs exceeding 20%.

Jon and I review every transaction regardless of size, and absolutely no money leaves this company without a thumbs up from me, Jon, or Stuart.

To date, we have been very pleased with the performance of our new communities, even as the market has trended downward.

During the second quarter, approximately 30% of our deliveries came from communities purchased or put under contract in the last few years.

Our gross margin on the closings in these communities was approximately 21% or about 200 basis points higher than the gross margin for the entire company in the second quarter.

From a geographic standpoint, approximately 32% of the new deals are located in Florida; 20% in Maryland, Virginia, and the Carolinas; 18% in California; 13% in Texas; with the remaining 17% spread throughout our other markets.

Our focus within these markets has been on desirable communities located in submarkets where people really want to live.

Whether the hook is schools, spectacular amenities, or commute time, each one of these new deals has been selected with a very specific target buyer in mind.

In short, we have stayed away from fringe locations or opportunities where price was the only driver.

Given our laser tag focus on land, our product strategy has been a key driver to our success in these communities.

We have ensured that we have a cost-effective home design in hand before we buy land, which has allowed us to streamline the time period between when we buy and when we're open for sales.

It's a true cash-on-cash focus.

We don't want to waste time chasing deals that fall outside of our floor plan universe.

This allows us to use real-time and proven cost information when we underwrite new deals.

As I've mentioned in the past, we have been direct sourcing the lion's share of our deals and have tried to stay away from the broker to bid transactions.

This has allowed us to get in early, buy or tie up multiple deals at a time, and negotiate much more favorable pricing and terms.

I have no doubt that we have the most talented and hard-working land team in the business.

This team working together with our Rialto Associates has been particularly effective.

We've worked closely with the banks, partnered with the government, fought for closed properties, tax certificates and community development funds.

We think that some of the best opportunities are the more complicated deals.

And I would like to thank our team for their hard work and dedication.

Now I'd like to turn it over to Jeff Krasnoff, the CEO of our Rialto operations.

Thanks, Rick, and good morning, everyone.

As he does each quarter, Bruce will shortly be reviewing the details behind our $9.8 million of operating earnings, along with the results for the rest of the company.

From an operating standpoint, Rialto's real estate portfolio, securities and investment management businesses, continued to be very busy.

During the quarter, our Rialto real estate fund, in which the company is both a major investor and the manager, closed on two new distressed real estate loan portfolio transactions representing $140 million of unpaid principal balance.

But we've also tied up another eight new loan portfolios, which subject to completion of closing conditions, should add loans with an additional $350 million of unpaid principal balance.

We also close on two new issue commercial mortgage-backed securities transactions and have two in the pipeline, representing a total of $320 million of securities backed by over $5.5 billion of newly underwritten cash flow and commercial real estate loans.

All told, with the transactions we've already completed and those in our pipeline, we estimate in the next 30 to 60 days, the fund will have invested approximately $340 million in equity since its inception late last year to buy approximately $940 million in assets at a little over a 60% discount to par.

As a reminder, in addition to the approximately $450 million of equity it has invested directly before the inception of the fund, the company has committed $75 million to be invested through the fund and has the ability to co-invest in larger transactions.

The additional equity commitments that we expect -- add in closings in the near future will be adjusting the company's ownership percentage in the approximately $370 million of commitments closed to date.

As we have mentioned in the past, we receive fees for pursuing and managing fund investments, and we also earn incentive fees based on the fund's performance.

Since we last reported to you, along with other fixed income asset classes, RMBS and CMBS have experienced a widening in spreads, thereby increasing yields and reducing pricing.

As Bruce will walk through, this had an impact on our mark to market this quarter for our investment in our PPIP fund with AllianceBernstein.

But it's also increased the attractiveness of certain targeted securities.

Therefore, for the first time in several quarters, our PPIP fund has called additional capital in order to be prepared for attractive acquisition opportunities.

On the operations side, we continue to build an outstanding team of professionals, which has now grown to over 150 associates across the country.

Our team is currently evaluating an unusually large pipeline of opportunities, primarily from financial institutions, divesting troubled loans that are burdening their balance sheets.

Already in-place managers are today working out loans, 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 that are pricing, we are positioned to quickly and efficiently bring those assets right into our already in-place workout machine.

And because of a higher percentage of loans made to developers, being able to efficiently incorporate the home-building team's unique view and expertise gives us another distinct advantage in our evaluation and maximization of value for these assets.

As part of this active collaboration, the home building divisions have also been able to capture distressed opportunities from the same institutions we've been working on the portfolios.

It's a mechanism to generate new communities at extremely attractive pricing.

Since we have started this program, this has led directly to the company's investment of almost $100 million to acquire thousands of extremely well-located home sites for use in the company's home building operations.

We remain very excited about a growing franchise, our current position in the marketplace, and the synergies with the rest of the Lennar team, and we look forward to reporting to you on our progress in future quarters.

Thanks, Jeff.

This is Bruce Gross.

Revenues from home sales decreased 6% to $650 million during the quarter, and that was due to a 9% decrease in home deliveries, excluding joint ventures, which is partially offset by a 2% increase in average sales price to $245,000.

The average sales price by region is as follows -- the East region, $233,000 up 5%.

The central region, $209,000, up 6%.

Houston, $231,000, up 7%.

The West region $308,000, down 3%.

And the other category, $269,000, up 6%.

The changes in average sales price were primarily due to product mix during the quarter.

During this quarter, we had only $3 million of home building community impairments, which is the lowest quarterly home building impairment amount since we started the impairment cycle five years ago.

Our gross margin on home sales pre-impairment was 19.9% as Jon mentioned, and that compares with the same pre-impairment amount of 21.4% in the prior year and 21.1% in the first quarter.

Gross margins were strongest in the East region this quarter.

The gross margins from our new communities continued to outperform, but were partially offset by a modest increase in sales incentives on homes closed.

Sales incentives increased by $2800 from the prior year to $33,900 and increased approximately $800 from the first quarter.

As a result of the strong operating leverage noted in our sequential 150 basis point improvement in SG&A to 14.9%, our home building and operating margin, also pre-impairment, also improved sequentially from the first quarter, as it was up 30 basis points to 5%.

Other income net totaled $9.5 million in the second quarter, of which $5.1 million was due to the hard work of our associates and resulting in a favorable resolution of a joint venture.

And the remainder was primarily management fees and interest income, which you typically see each quarter.

Our financial services business segment generated operating earnings of $2.3 million for the quarter versus $13.7 million in the prior year.

The reduction was due to decreased volume in both our mortgage and title operations, and the prior year results included a $5.1 million gain relating to the sale of a cable system.

Mortgage pretax income during the quarter was $5.3 million, and that compares to $9.3 million in the prior year.

And our title company had a $2.2 million loss compared to a $400,000 loss in the prior year.

Our Rialto business segment generated operating earnings of $9.8 million, and this number is net of $12.9 million of net earnings attributable to noncontrolling interests.

The composition of Rialto's $9.8 million of operating earnings by type of investment is as follows -- $9.5 million is a contribution from our 40% share of FDIC portfolios; $11.9 million from non-FDIC portfolios; $2.4 million loss is from PPIP, less approximately $8.3 million of G&A and other expenses, which are net of management fee income.

The $9.5 million of contribution from the FDIC portfolios this quarter is primarily from accretable interest income, collections from guarantors, and gains upon foreclosure of REO.

The $11.0 million of contributions from the non-FDIC portfolios is comprised of a accretable interest income, sale of REO, gains upon foreclosure of REO, and a $4.7 million gain on the sale of a CMBS bond.

The $2.4 million loss during the quarter from our investment in PPIP, as Jeff discussed, is reported as equity and earnings from unconsolidated entities, and this loss is comprised of a $5.5 million unrealized loss due to the mark to market adjustment from the widening spreads discussed by Jeff.

This was partially offset by $2.6 million of interest income in the PPIP.

At quarter end, Rialto continued to generate cash.

They had $160 million in the [deficient] cash account to retire debt, and there was an additional $70 million of cash on Rialto's balance sheet.

Lennar's balance sheet continued to be strong and liquid at the end of the second quarter, and our leverage remained low.

Our home building debt to total capital net of the $945 million of cash was 44.9% at the end of the quarter, and inventory, excluding consolidated inventory not owned, stayed flat at $3.9 billion.

Our backlog conversion ratio during the quarter increased to 138% as we remain focused on carefully managing our inventory levels.

This conversion ratio was higher than normal as a result of our successful focus on reducing our completed unsold home inventory account from 1,059 at the end of the first quarter to 696 at the end of the second quarter.

We had 449 active communities at the end of the quarter.

And as a result of another profitable quarter, we were able to continue to reduce our deferred tax asset reserve, which now stands at $599 million.

Shareholders' equity increased to $2.65 billion, with a book value per share of $14.18.

In conclusion, we are pleased with our continuation of reporting quarterly profits.

And given current market conditions, we remain confident that 2011 will be another profitable year for the company.

And with that, we will turn it over for questions.

Dan Oppenheim, Credit Suisse.

Thanks very much.

Was wondering if you can start off talking about the strategy in the home building business.

You talked about a real focus on minimizing the level of specs there, but if you look at the backlog conversion, it would seem that you've got a lot of homes that are converting to sales pretty quickly.

How do you describe that in terms of what you are doing to specs and how you are managing that process?

So, Dan, with respect to managing the specs, we're matching our sales and our construction pace.

This particular quarter, we had about an extra 360 or so homes that were able to close because they were completed, and our strategy is to focus on those homes and keep that count as low as possible.

But from a standpoint of what we are starting in construction -- and Jon, maybe you want to touch on this -- we're matching that with our sales base.

Sure.

We monitor the absorption community by community and accordingly, set a start pace for that specific community.

The other thing, Dan, that we experience in today's market is that our biggest competitor is the existing home.

And the brokers, particularly, and the customers are comparing a finished home to our homes and the ability to have some homes that are near completion really allows us to compete more effectively with the existing home.

And of course our focus on cycle time also allows us to effectively control the fact that we have started some homes that aren't sold yet.

Great, thanks.

And I guess second question, wondering about the pipeline of transactions in Rialto business is unusually large.

Any sense in terms of what you've been seeing in the past as you've been looking at transactions, in the pipeline, what percent ends up closing?

How realistic it looks to be in terms of say large volume here in the next couple of months?

It's Stuart.

Maybe Jeff will follow up, but in terms of pipeline, our pipeline percentage that end up closing, it's been about 100%.

We -- we're pretty much looking at a pipeline that we don't tie up unless we have done due diligence ahead of time and we have a pretty strong degree of certainty that we're going to close the deals that we have tied up.

In terms of the pipeline of activity that's out there, there is no question that the market is really starting to put out a lot of product that has been pent up and saved up inside of the lending institutions for sometime.

So the activity is clearly getting pretty heavy right now.

We're underwriting a pipeline of new potential deals that is much larger than we have seen over the past quarters, and we expect this activity to continue for some time now.

Jeff?

Yes; no, I would say a large percentage of what we're looking at are negotiated transactions, and usually when we start going down a path, we typically end up with a deal at the end of the day, with some give-and-take with the financial institutions.

In some cases, we do, if we think that it's going to be a very thinly bid transaction, we may bid some transactions, and there might be a few of those that don't get done because they don't get done at our price.

But for the most part, the supply right now is overwhelming a number of qualified buyers really in the marketplace.

And at the end of the day, the number of deals that are out there really enables us to be very selective about what we are buying, and more importantly, the price at which we are purchasing.

Great.

Thanks very much.

Ivy Zelman, Zelman & Associates.

Thank you.

Good morning, guys.

We've got a lot of questions from investors on is it better to be land light or have land given that the outlook seems pretty ominous right now by many?

And also, should you be a move up or entry level, and seem to be a push to move up.

So realizing that's two questions in one, if you can try to help us frame your views of that?

And lastly, I will get my second question in without getting back in queue -- pricing review and what pricing dos when you're underwriting ground, or you think it's going to continue to go down over the next 12 months?

Well, on the land light versus land heavy side, Ivy -- this is Rick -- we're being very opportunistic with regard to what we are putting under contract, how we're underwriting it, and when we are investing the dollars.

All we can really point to is what the numbers have been with regard to the investments.

Pretty much across the board, we have invested in new opportunities that far exceed the gross margins in some of the legacy assets.

So from a cash investment and a return standpoint, those things have been really money good.

As we look at the cycle, and we look at the opportunities out there, we have changed some focus at various times in different markets from some of the finished product is available out there because some of that has been bid up to things that may be more busted deals that give us an opportunity for really outsized returns as we fix the issues that are out there.

Pricing -- we have seen pricing bounce around.

As I said in some of the prepared remarks, when we underwrite these deals, we underwrite them with multiple variables in mind.

We look at them on a base case as if everything is flat.

We look at them with declining sales prices, declining abortion rates, cost inflation; really we split it and we analyze it in multiple ways.

At the end of the day, it needs to pass muster at the worst-case scenario based on absorptions, based on price decline, based on cost inflation and all of those type of variables.

And once it does that, we make the investment decision.

Let me just add to that.

You asked about pricing assumptions relative to our underwriting.

We're buying a variety of types of properties these days.

Some of them are shorter term under eight land light kind of concept.

In those instances, we are not making pricing assumptions to the upside or downside.

We're looking at normal market conditions.

We're coming (technical difficulty) staying very close to the market.

We are probably predisposed more towards move up right now.

But in longer-term land positions, we're leaving ourselves a lot of flexibility.

I don't think that we can look at current market conditions as a proxy for where the market is going to go over the next couple of years.

Great.

Thanks, guys.

Michael Rehaut, JPMorgan Chase.

Thanks.

Good morning, everyone.

First question, just on May, in the press release, you discussed it being up 30% year over year in terms of orders.

I was wondering if you could give us a sense of sales pace and also how pricing and incentive trends have been relative to -- sequentially relative to April just this -- just month to month how you have seen things trend.

Sure, Mike.

This is Bruce.

The sequential trend from April was pretty flat as you look at pricing and as you look at the sales incentive trend.

So we have hit somewhat of a stable point.

It was sequentially improving throughout the year, and then from April to May, it's pretty flat.

And that flatness would then be also with regards to sales pace?

Yes, sales space is about flat as well.

Okay.

Second question on the gross margins -- still staying in that essentially that 20% to 21% range.

I think basically you said last quarter that the backlog gross margins were roughly 20% -- at the 20% level.

So I guess the question is, going forward in the next couple of quarters, you expect to remain essentially in that 20% to 21%?

Or given the perhaps slight increase from closings from new communities or to the extent that you can perhaps achieve some further benefits from lowered costs per square foot, are there any things that might drive your expectations towards higher -- the higher end of that 20% to 21%?

Or just how should we think about that going forward?

Hey, Mike, this is Rick.

As I said last quarter, I think the zip code that you really should focus on is really 19% to 21%.

Because Jon and I every month, every week, are making pricing decisions with regard to market movements that are real-time.

Clearly, the new communities have the ability to push the overall blended gross margin up to the higher end of that range, but we have to react on a daily basis to the local market movements, the traffic conditions, and it's going to sort of move in that category.

And if you look at the guidance that we gave you last time, we sort of came in right in the middle of that curve.

Mike, to your point about direct cost reduction, we continue to look forward and expect we're going to have to continue to reduce cost structure in the current market environment knowing that price pressure can continue to move downward.

And so we are forward thinking and forward looking in terms of what's the next solution to deliver value and reduced cost.

Great.

Thanks, guys.

David Goldberg, UBS.

Good morning, everybody.

My first question actually, somewhat of a follow-up to Mike's question, and I appreciate the details on the cycle times and the direct cost per square foot, but I'm trying to get an idea of how you guys benchmark your efficiency and your purchasing relative to kind of your internal goals and your targets, and also relative to what your competitors are doing.

I'm just trying to get an idea kind of maybe what's left for you there in your minds, and how you kind of -- as you think about it over time, how do you determine how well you are doing?

It seems pretty impressive, so.

Well from a benchmark standpoint, I think that we feel that we are doing the best job in the industry.

And we've got great people in the field.

We've got excellent purchasing folks.

We are construction superintendents.

Our builders out there are focused on keeping that house moving from the day we pour the slab until we give the keys to the buyer.

The cycle time is incredibly important in this company.

And, how much further can we compress that time period?

That's going to be a lot driven by the increased efficiency and the designs and some of the things that we're doing along those side.

From a cost perspective, a purchasing perspective, we are continuing to battle with some of the influence of the manufacturers of trying to push costs up, but we have been very effective in keeping things down.

And what's going to be interesting is what happens when the cycle turns, and how much of that cost increase that we can battle against.

But I think that when that happens, we shouldn't be able to more than offset that with price increases of our product.

You know, at the end of the day, I think that we've set no limits on ourselves as to how far we can drive cycle time down and cost down.

We think that there is room for marginal improvement as volumes go down.

Everybody through the supply chain is under pressure, and we keep that pressure applied.

We recognize that there's going to be some give back as the market comes back.

But while the market has been trending lower, we are looking for participation from the cost side of the equation to keep us in a steady profitable zone.

So we think that there will be more movement.

We know that there is pressure to the upside.

Everybody is trying to make a dollar here.

But while the market is moving down, we think that we can make some more improvement.

Got it.

And then just my follow-up question here.

Interesting to hear about -- more talk about the reinvigoration of Everything's Included.

I'm wondering if you can talk about -- you know you also talked about in your individual communities, your individual markets, building the product that meets the customer demand.

And I'm trying to get a sense of how much your Everything's Included product, what is included differs market-to-market, buyer segment to buyer segment.

Do you find that people generally want the same things in most of your markets, and so you get to know more purchasing power on more of a national basis on some of those products?

Or is it kind of different market-to-market (technical difficulty) some color on that.

Let's start by thinking about it this way, and Jon will add to this.

But think of Everything's Included as kind of a three-tiered program in today's world.

It's about an energy program.

It's about technologies, modern technologies, and it's about included features.

We are fully focused on energy savings as a differentiation mechanism from used and foreclosure homes.

That's our biggest competitor.

And it's the biggest area of vulnerability for that competitor.

New homes offer a better energy program, and we're doing everything we can to enhance that, and that's pretty much across the board.

The energy component of Everything's Included is something that it might vary somewhat market-to-market based on whether we can do solar in one market or win loads in Florida and things like that, but we are focused on the energy component.

Technology comes down to you know, you wouldn't buy a car with roll-down windows.

We want to enhance the technology around our homes to where we are competing with that existing home market aggressively by enhancing the technology, today's technology, around home ownership.

That means keyless entry doors and switchless lighting and stuff like that.

We think that we can enhance that program and that we are doing market to market.

The features component of our Everything's Included program is a highly researched, highly market-focused component.

And that's the third leg of Everything's Included.

And there, we do a lot of product research.

We are basically looking to deliver the home that our customer would select if they were going through the selection process.

And that means that our people in the field are doing a lot of product research to come up with the end solution for the home buyer that they would choose if they were choosing it on their own.

So we are doing the work for them, and that's very locally market driven.

That was going to be my point.

It really starts with market research, and it does lead us to different answers in different markets.

They're just different taste relative to style and likes from someone living in Florida to somebody living in Minneapolis to someone in Phoenix.

They tend to fall into common categories, but the application and execution of that will definitely vary market by market.

Yes, that all comes down to market by market, what do they want in that home?

What would they select on their own and balancing that with what they can afford, and putting that package together in the most dynamic way possible.

Got it.

Thank you.

Jade Rahmani, KBW.

Yes, thank you for taking the question.

Just on Rialto, I wanted to find out has the timeline for deals coming to market, due diligence, spending or anything related to the process, materially changed?

It seems that one change is you're looking at more and more negotiated transactions.

And then the follow-up would be, I take it from your comments that based on what's expected to close in the next 60 days that the opportunity fund is fully invested.

Can you give the schedule of future commitments on this fund and Lennar's incremental investment?

And if you raised a follow-on fund of this size, what do you think the timeline for capital deployment would be on that?

Thanks a lot.

Well, I would say first off I think you hit it right.

We are certainly doing a number of negotiated transactions, and a number of them are with sort of repeat -- are repeat sort of sellers for us, and that market is growing.

We're trying to add new people to that program as time expands.

And as it relates to the equity, I would say that we are still in the market, so I can't necessarily give you a lot of information on that other than the fact that we do expect to have continuing closings on commitments for this fund before closing it up and starting to raise the next fund.

But look, just to add to that, I think that the field of opportunity has expanded.

There is a great desire on behalf of the sellers to end up with a transaction that actually closes.

There's a lot of noise out there, a lot of participants in the market, that are not experienced in this arena.

And so the certainty of close becomes a little bit more questionable with some.

There's a premium placed on groups like ours that have the ability to come in, and in a credible way, diligence the offering and come up with a deal that will actually close.

We bring that to the table.

That's a differentiation from how the deals had been over the past quarters.

I think we have an advantage.

It gets us in the door and gives us an advantage in terms of putting together a program that we can purchase at attractive pricing.

It -- in terms of our ability to invest, we have invested the fund money very efficiently and effectively at what we think are very attractive returns.

We will continue to invest fund money as we go forward, and we think that we are not going to be capital constrained.

Just a clarification -- is there a maximum size on the opportunity fund that you could disclose?

And also how you think about Lennar's capital allocation to Rialto -- is there some limit to how much you would invest?

Thanks a lot.

I think we have stated that in terms of this fund, that Lennar's commitment is $75 million, but it also has the opportunity if there are larger transactions as a co-invest side-by-side with the fund, so we do have that.

I don't believe we have actually disclosed the total amount of -- the maximum amount of the fund.

But on the face of it, it is -- the first fund was $750 million.

Right.

Let me just add -- in terms of Lennar's investment, we are investing capital through our Rialto fund and through our Rialto program.

The returns are really the primary driver behind how many dollars we will invest on the Rialto side versus land opportunities for the home building side.

Where we find outsized returns, that's where the dollars will flow.

And as a company, we remain opportunistically focused on how our capital gets invested.

Megan McGrath, MKM Partners.

Good morning.

Thanks.

I wanted to follow up a little bit on the pricing environment and the incentives.

I'm wondering if you could give any more color on the increased incentives.

Did they come at a particular time in the quarter for a particular product?

Was it to get rid of that spec mostly?

Or do you think they will kind of stay at this elevated level at least?

Did you see that in June?

Thanks.

On a percentage basis, it stayed relatively flat throughout the quarter.

And as we have said in prior calls, we use our inventory as a tool, and we price to close to hit the pace of what the operation should achieve.

We haven't seen a dramatic change one way or the other in -- post the quarter.

This is Jon.

As you look back the last three quarters, it's really been relatively flat.

And like everything else, it's very local and it does vary market by market and what's happening within those regions and submarkets.

Great.

Thanks.

And then just a little bit of switching topic.

I wanted to follow up with Jeff on your comments around the unusually large pipeline.

Any thought as to what's driving that on the part of the bank?

Do you think they're coming under pressure?

Do you think their outlook for real estate has gone down?

What do you think is increasing the pipeline so much?

Well, I think it's all of the above.

I think they're getting increased pressure from regulators.

I think that they are also -- there's also a lot -- there's also pretty significant fatigue that set in, in terms of some of the portfolios that they've been trying to work for some period of time.

And I think that right now, they're looking at the marketplace and they're looking at the opportunity for buyers like us to be able to dispose of these assets or get them off their books.

And I think that all of those dynamics have sort of worked together.

And it's -- on the other side of it, in terms of the number of investors, there are still relatively few that have the kind of infrastructure that's required to be able to look at large portfolios that cover diverse geographic areas and property types and so on.

And as a result, as a result, sort of the supply right now, the way we see it, has sort of overwhelmed the demand.

Great.

Thanks.

Kenneth Zener, KeyBanc.

Hi, this is [Rodney Nassay] on for Ken.

Hello, everyone.

I wanted to clarify, on the units under construction, how many units do you have finished and how many are under construction?

And how does that compare to last quarter?

So, we indicated that we have 696 that are completed unsold, which compares to 1,059 last quarter.

And what's under construction both sold and unsold is approximately 3700 versus just under 3,000 last quarter.

Okay.

And with 449 communities at the end of 2Q, how many communities do you expect to have active at the end of 2011?

We don't project that, Rodney, because it's too hard to predict how many communities would be falling off as well.

So the number will increase because we're finding good opportunities and investing capital, but we don't actually put a prediction out because it's too hard to project that.

Okay.

All right.

Thank you.

Nishu Sood, Deutsche Bank.

Hi, this is actually Rob Hansen on for Nishu.

You briefly touched on lending standards and just wondered -- to see -- get your thoughts on how tight they are.

We recently heard from one builder that said that for the first time in three years, they saw a slight easing in lending standards, so just wanted to get your thoughts on that.

Thanks.

Well, that kind of takes me a little bit by surprise that you're getting that feedback.

I think that the lending standards are pretty tight right now.

And even stated standards where you might find that a FICO score of 580 is prescribed, the actual underwriting is probably solving to something in the 620 or 640 range with conservatism built in, given the fact that some of the rules are uncertain and some of the -- some of the holdback requirements and requirements to almost guarantee loans that are being put in programs is out there.

It's our experience that there is a lot of pressure to maintain kind of an ultraconservative [spend] on kind of government-sponsored loans.

We think that that's kind of a crimp in the demand that's naturally out there right now.

And it seems that over time, there will be a form of loosening of that tightened credit standard.

When that will actually take place or how it will be effectuated is something that I don't think anybody can predict right now.

But I do think that financing is a big, limiting factor for natural normalization of demand right now.

And it's an opportunity for the housing market, as we look ahead -- an opportunity for the market to correct.

This is Jon.

As you think about it, in every market, you have record affordability, which typically brings out first-time buyers who weren't able to afford to purchase a home in better times.

And what we are seeing today is for that first-time buyer, the administrative hurdles of credit today make it very difficult.

And for that demand that is out there, Stuart noted, it's very hard to convert into an actual homeowner.

All right.

Thank you very much.

Adam Rudiger, Well Fargo Securities.

Hi, most of my questions have been answered, but I just wanted to first ask housekeeping -- if you could tell me owned versus [auction] lots.

And then I had a question on SG&A.

I would have expected probably I think a little bit less of a sequential increase in SG&A given -- I would have thought I guess there's usually more operating leverage there, more kind of a fixed cost we're currently running at, so I was wondering if you could comment on that, and maybe if possible break out within the SG&A, what part of those expenses might have been attributed to new community openings.

Let me give you the piece that is owned sites -- owned and controlled.

We had 108,000 total owned and controlled, of which 91,000 was the owned piece during the quarter.

And, as you are looking at SG&A sequentially, keep in mind that we've been opening at least I think it's around 50 communities or so per quarter.

And as part of that, we do expense some of the cost of the models and grand openings before you have any deliveries.

So there is a piece of that that goes through; I don't have the exact percentage per say, but that's (technical difficulty)

(technical difficulty) we should assume that there could still be some additional cost running through there?

And any idea that -- I think some other builders have talked about being at a somewhat of a fixed cost level right now and you can increase volume without any corresponding increase in expenses.

Is that potentially a little bit inaccurate given that you have all the new community opening still?

Here's the way we look at SG&A.

We think there is significant operating leverage in SG&A.

And the formula that we have put out there is as we open a new community in an existing division, the incremental SG&A percentage attributable to new deliveries in that community is about 7%.

So we think as we go forward and we increase deliveries from these recent community openings, there is operating leverage that will reduce the SG&A percentage going forward.

Thank you.

And I think we will take one more question.

Stephen East, Ticonderoga.

This is [Paul Shobalfian] for Stephen.

Your orders have been trending down for several quarters now in Houston and I was wondering if you might be able to give a little bit of color on the reason behind that.

Well, this is Rick.

Houston continues to be a really tough market.

We have had some things go on in the market that are somewhat aberrational starting with the oil spill, and stemming from that, the curtailment of a lot of oil and gas spend, given the activity that went on there.

In addition, there was the Continental-United merger, which was had a big impact on the employment base there.

And we are starting to see a stabilization of what we've got going on in Houston.

From an income statement, the division still operates on a profit for us.

And we're looking at over the next several quarters to see that turn around.

We think our communities are very well located there.

There's no doubt in our mind that we are really outperforming the competition in that market.

It's just very noticeable when you had a very large division that we've broken out on an individual line item -- go through a very tough market correction.

Okay, thank you.

And then your community count growth was a little bit lower than we were expecting this quarter, and I guess that you've been opening roughly 50 communities a quarter.

Were there more closings, closeouts, this quarter?

Yes, there were several communities that came to their end, either because we built through them or decided to walk away from them, benefiting from the options structure that we had with regard to those deals.

You will see through the balance of the year as things come on book and things move off; we are very encouraged when we get to move through some of our asset base and so that -- we view that as a pretty good thing.

Okay; so the net increase is probably in line with what we should expect for next quarter as far as community growth?

Well, as Bruce said, we try not to give you projections on community count.

The timing of when they open, there's lots of variables.

But I think that the trajectory is towards the upside, and that's what we have said for the last several quarters.

Okay.

Thank you.

Great.

Well thank you, everybody, for joining us.

And we look forward to keeping you posted on our progress and reporting again next quarter.

Thank you.

This will conclude today's conference.

All parties may disconnect at this time.