Lennar Corp (LEN) 2012 Q2 法說會逐字稿

Welcome to Lennar's second quarter earnings conference call.

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

After the 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 Allison Bober for the reading of the forward-looking statement.

Good morning.

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

These forward-looking statements may include statements regarding Lennar's business, financial condition, results of 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.

Thank you.

I would like to introduce your host, Mr. Stuart Miller, CEO.

Sir, you may begin.

Good morning, everyone, and thank you for joining us for our second quarter 2012 update.

We're very pleased to detail our results for you this morning and we have a lot of ground to cover.

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

And of course, you just heard from Allison Bober.

I'm going to begin this morning with some brief opening remarks about the state of the current housing market in general and about our second quarter results, and then Rick and Jon will comment on specific aspects of Lennar's homebuilding operations and Jeff will update performance on our Rialto segment.

David Collins is going to also give a five minute primer on our deferred tax asset reversal.

And finally, Bruce will provide detail on our first quarter numbers.

After Bruce, of course, we'll open the phone lines to your questions.

And we request that everybody please limit to just one question and one follow-up so that we can be as fair as possible to everyone.

So as I sit here today, I couldn't be more pleased with the progress that our Company has made and continues to make as we work through this historic downturn.

The associates throughout our Company have worked tirelessly to pull through the toughest of times, to revamp our business from top to bottom, and to move forward to stable profitability.

The reversal of our deferred tax asset reserve this quarter is really a tacit recognition of a job well done, and it's symbolic of having accomplished a great deal to bring Lennar back to a strong go-forward position.

And in that regard, I want to thank all of the associates of our Company for the commitment and care which are at the core of the culture of our Company.

The reversal of our deferred tax asset reserve this quarter is, as I noted before, really symbolic, rather than a significant financial event.

It represents that the Company has really achieved a stabilized financial condition, consistent profitability, and even a modicum of visibility as well.

It also represents that the macro housing market has stabilized, has most likely bottomed, and perhaps is beginning the road to recovery.

I've noted over the last few quarters that we've been seeing consistent improvement in both traffic and demand activity in our communities.

This has acted as confirmation that both the housing market and the overall economy are stabilizing and that a very real trend is beginning to take shape.

The overall housing market is different now than it has been in the past several years.

There are discernable fundamental shifts that are driving the home market, and there are empirical data points that are to date confirming the market it really showing signs of stability.

With that said, and as we saw from yesterday's Case-Shiller information and last week's home sales data, the housing market is not yet in full recovery, as the actual data is still slightly negative in some instances.

In fact, the stabilization process, after a full seven-year decline in housing, is still somewhat rocky and erratic, and is certainly not yet broad-based.

Our management team has just completed our quarterly operations review with all of our Division Presidents.

Let me tell you what we're seeing in the field and how we're thinking about the market versus national numbers that are being reported.

We're seeing that various important themes are primary drivers of today's housing market.

First, today's consumer is looking at the home purchase differently than in past years.

Today's buyers are looking for real value, as defined by low purchase price, low interest rate, and affordable and competitive monthly payments.

The home purchase is not seen as a place to invest savings in order to ride the wave of price increases.

Since home prices and volumes are low and interest rates are at historic lows, affordability is at extremely high levels.

Today's consumers are realizing that housing represents an undeniable value proposition.

They are finding real value in today's for sale housing and we're hearing this from them regularly in the field.

Accordingly, for the past few quarters now, we've been experiencing more traffic in our Welcome Home Centers, and customers are actively discussing their desire to find a way to purchase and capitalize on current market conditions.

A second trend is that purchasers are beginning to feel pressure to make a home purchase so that they do not miss this moment in time.

The feeling of missing the boat is becoming a common discussion and is being reinforced by discussion with family and friends.

Buying a home -- buying and owning a home is not only no longer taboo at the dining room table, it is being viewed as a measure of financial stability again.

This trend will continue to drive demand and sentiment as more data becomes positive, as the press continues to highlight recovery and as inventory in the field continues to deplete.

Next, consumers are becoming acutely aware of the comparative value in monthly payment, in a mortgage monthly payment versus a rental monthly payment.

The fully loaded cost of ownership is simply lower in most desirable markets than comparable rental rates.

As I've noted in past conference calls, we have and continue to carefully study this trend and continue to find that in local competitive markets, principal, interest, taxes, insurance, community association and lawn care are together lower than the competitive rental market.

Today, for sale housing represents an excellent value proposition on a pure monthly payment basis versus renting.

Rental prices are high and they've been moving up, as well.

Today's consumer is looking for living cost stability, as well as a stable and safe place to raise the family.

Accordingly, today's housing consumer is seeking to avoid the rental market and the annual repricing inherent in rental rates.

Fourth, consumers recognize that the mortgage approval process is extremely conservative and is very difficult -- and it is very difficult to get approved.

Expectations are aligning with the new realities of the mortgage market, and consumers desirous of purchasing and getting approved are becoming more realistically in touch with their own credit credentials in order to be approved.

Rather than fighting the process and leaving in frustration, consumers are working within today's parameters to provide the burdensome paperwork, accumulate the required money down, and enhance their credit credentials to get to the finish line.

Fifth, inventories are declining.

While there might be national statistics that suggest otherwise, or suggest that foreclosure backlog and delinquencies are still a looming problem, we are finding that inventory overhang is diminishing in many markets and that available for sale housing is becoming more scarce.

Additionally, with the government's recasting of HARP 2.0, that is the home refinance program for performing but underwater loans, there are far fewer strategic defaults, as more owners are refinancing and appreciating a lower monthly payment.

Finally, improvement in employment and consumer confidence is finally translating into the end of negative household formation.

The trend of children moving home and elderly parents moving in with children is at least slowing and starting to reverse.

Over time, this trend will be an even more powerful driver of demand.

I have always noted that it is generally 6 to 12 months after households double up that everyone realizes that this was just not a good idea.

As the economy improves, doubled-up households can afford to unwind, and this is beginning to happen.

Overall, demand has been improving and we've seen consistent sales pace at stabilized prices through our second quarter as a continuation of a trend from of our prior quarters.

Our steady traffic and sales rate indicate stronger demand trends than prior years and we've seen an increase in our monthly sales per community as well.

And these improved results are coming with prices and margins that are consistent, or marginally better, than our current deliveries, indicating that we are not and have not been reaching for volume.

With these trends identified, I do not want to overstate the case for housing.

While the trend is discernibly positive, stabilization and recovery are uneven across the country, and even within markets.

The housing depression was a national phenomenon, while the recovery is decidedly very local.

We're seeing pockets of activity develop across the country, not by region or by state, but on a very localized basis.

And these pockets are recovering while the broader market outside of these pockets often remains weak.

But at present, these pockets are growing.

Additionally, demand remains constrained by the mortgage qualifications standards and processes and a difficult appraisal environment that define today's mortgage market, that has been over-corrected by the severity of the downturn.

But demand is growing, and more and more customers are pushing to fit within the boundaries of credit standards, while the government has recognized that the pendulum has swung too far and is pushing for some loosening of credit standards, as well.

Let me briefly turn to Lennar specifically, as our management team will give additional color on our results.

In our second quarter, we saw fundamental improvement in all of the building blocks that define our Homebuilding and Financial Services operations, while Rialto continued to build and augment its blue chip operating platform.

Each of our operating segments has remained profitable in the second quarter, as our associates across the country are executing on all fronts.

On the Homebuilding front, closings were up 20%, new orders increased 40%, our backlog improved 61%, and gross margins of 22.5% translated into our healthy operating margin of 9.2%, as SG&A declined to 13.2%.

We're beginning to see the impact of the operating leverage that we expected as the market stabilizes.

As we look ahead to future quarters, our strategy of focusing on high margins in well positioned communities will continue to be the primary engine that drives SG&A operating leverage that will continue to produce strong and sustainable bottom line earnings.

Lennar's Homebuilding operations are operating soundly and are defined by excellent hands-on management running the day-to-day activities, while excellent new communities are identified and added to each division.

Lennar Financial Services had another excellent quarter as well, leveraging the core Homebuilding business, providing excellent service to our customers, and adding incremental volume by participating in the refinance market, as well.

In the second quarter, Rialto continued to be a central part of the improving Lennar story.

While current earnings of $4.3 million fell short of our expectations, the contribution that our Rialto connections and relationships have made to our core Homebuilding business has exceeded every expectation we had when we began to grow this business.

In this regard, I have to highlight the credible work of Eric Feder, who has been the bridge between Rialto and Lennar managers, and has maximized this synergy.

The Rialto franchise will continue to be a significant source of valuable Homebuilding deals for some time to come, while the base Rialto business ramps its earnings.

As we look ahead, Rialto should continue to be a solid earnings contributor for Lennar, and will begin to return cash to corporate as it now -- as it is now investing self-generated funds.

I would be remiss if I did not briefly address the recent press coverage on a financing deal with a Chinese bank on our Hunters Point and Treasure Island partnerships.

While we do not comment on deals that are in negotiation or not closed, I will say that we have a great number of very exciting dealings around various strategic assets that will reveal themselves over time.

Of course, we will make material announcements as appropriate.

All in all, our second quarter 2012 results mark an excellent stepping stone to our future performance.

We're feeling more and more comfortable that the current trend is not an aberration, but the beginning of a new cycle for housing.

This sense derives from extensive feedback from our people in the field and from the nature of the shift in the consumer's mindset.

As I look ahead to the remainder of this year, and towards 2013, I am increasingly optimistic that we are seeing a real bottom in housing and that we will continue to see signs of recovery.

National statistics and news will give us some mixed signals as we move through the year, as they represent a compendium of all of the best and the worst markets around the country.

But I feel that stabilization and recovery will emanate from the most desirable markets and spread outward over time.

Lennar is positioned with a strong balance sheet, is in the right markets, with an exceptional management team and a well constructed strategy to perform solidly as market conditions continue to improve.

All of the segments of our Company are performing well and are extremely well positioned, as you will now hear from our operating team.

Rick?

Thanks, Stuart.

We are really pleased with our operating results this quarter.

These results were driven by both the well-executed land acquisition strategy and a fine-tuned homebuilding machine.

I'm going to review our land activities and explain why Lennar is positioned to succeed in today's land market.

Jon is then going to discuss our building activities and how we maximize our gross and operating margins.

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

This quarter, we purchased 4,561 home sites for $206 million, and we spent $81 million on land development.

Combined, our land acquisition and land development spend was up about 74% over the prior year period.

In addition, we signed option contracts to acquire 1,597 home sites.

From a geographic standpoint, approximately 29% of our land purchases in the second quarter were located in the Mid-Atlantic, 23% in the West, 22% in Texas, 14% in Florida, 7% in the Pacific Northwest, with the remaining 5% spread throughout our other markets.

The lion's share of our new land deals were sourced outside of a competitive bid environment and were relationship-based deals.

As in prior quarters, money was invested geographically in the markets where we saw the best opportunities.

In Q2, we continued to acquire great deals in Florida and Texas, but invested more heavily in some extremely high margin opportunities in California and the Mid-Atlantic.

You will continue to see quarter to quarter changes in the geographic mix of our land purchases, as we capitalize on the best opportunities out there.

While the land market has heated up recently, our pipeline of land that we're actively negotiating is robust.

More importantly, over the last several quarters, we put under contract or letter of intent over 24,000 home sites that have yet to close.

And you should note that since these home sites are still in the diligence process, that they are not included in our home site owned or controlled total that I will give you later.

Consistent with our land -- our prior land purchases, these land deals have been underwritten to exceed a 20% gross margin and a 20% IRR with no inflation.

To date, we've been extremely pleased with the performance of our new communities.

During the second quarter, approximately 48% of our deliveries came from communities purchased or put under contract during the last three years.

Our gross margins on closings in these communities was approximately 200 basis points higher than the gross margin for the entire Company in the second quarter.

By this point, it should be clear that we've invested wisely.

The numbers truly speak for themselves.

And as the housing markets recover, we believe we will continue to outperform the industry, given our expertise and land acquisition.

Let me explain why we will continue to be successful and how we are different from our competition.

Number one is sourcing.

We are fishing in a different pond.

We have created many deep-rooted relationships with banks and other local seller that provide us access to deals that are not on the open market.

Number two is speed.

We move quickly to assess, analyze and respond to new opportunities.

We digest information quickly, and we have a streamlined approach to tying up a deal.

We respond immediately to contract issues and can get a deal signed faster than anyone else.

We are business people and don't let our lawyers control the deal.

Expertise.

Our key land associates have the knowledge and ability to negotiate complex deals.

We do not shy away from complicated deal structures.

We have the financial strength of a large Company, but the agility and expertise of sophisticated private investors.

We are not a big bureaucratic organization where the deal needs to fit within a box.

Fourth is credibility.

Our due diligence process is systematic, thorough and effective.

We commit to understanding the issues while we're pursuing the deal, thus when we sign a contract, we very rarely have to renegotiate because we took time to understand the facts and nuances of the deal up front.

This no re-trade credibility has given us the reputation of a Company that gets deals done.

In turn, we have become a preferred buyer.

Fifth is persistence.

When we identify a deal, we will pursue it until there's absolutely no chance that we will not get it.

We do not accept the first no as an answer, and we will relentlessly pursue the deal, constantly reviewing whether there's an alternative deal structure that can turn the no into a maybe and ultimately a yes.

Six is performance.

Our consistent operating performance gives us the ability to engage sellers at a different level.

Our execution in opening communities and driving traffic, as well as our product selection and EI platform, differentiates us from other builders.

This tends to give us a first look at deals, and often makes us a perfect builder in a multi-builder community.

And seventh is Rialto.

We buy more than just land.

We have the expertise to buy assets that will turn into land, such as CDD bonds and bank notes and mortgages.

This provides us a constant stream of high margin opportunities.

No other home builder has this depth of experience.

Let me give you a few examples of how these factors have positioned us to succeed.

Recently, another public builder signed a deal with a local developer for the first phase of home sites in a very large, multi-phase community.

Through our Rialto connection, we learned that a bank owned other home sites in the community, and we approached the developer to jointly purchase these home sites.

As partners in a very small piece of the community, and with 24/7 access to the developer, we built a close relationship with the developer and secured a key opportunity in the balance of this multi-phase deal.

The critical elements here were the Rialto connection, the relentless pursuit and creative approach to finding a way into a deal that someone else controlled, the relationship we built with the developer, and the strong performance of the initial partnership.

In another transaction, an out-of-state bank foreclosed on the last section of a very desirable community.

They approached several buyers with a very complicated deal term and a short diligence period.

Many builders balked at the deal, due to its complexity, while others, according to the bank, wasted a great deal of the bank's time trying to understand the issues.

Our team was successful not because we paid top dollar, because we didn't.

We got the deal done because we had the financial acumen and intellectual capacity to get it done quickly.

As a result, we have positioned Lennar as the go-to company for deals in that market.

My last example has to do with CDD bonds.

On previous conference calls, I've described that we've actively pursued bond purchases as a way to back in to underlying real estate.

Because of the relationships we've developed over the last two years with the holders of the bonds, we're often contacted by them when they want to sell their positions.

These positions tend to trade very quickly and the purchase requires a unique knowledge of bonds, foreclosures and entitlements.

We have this expertise in Rialto and in our Homebuilding divisions, so we can immediately react to these first-look opportunities.

Before I turn it over to Jon, let me give you some final stats.

On a year over year basis, our Q2 inventory increased about $557 million, to approximately $4.4 billion.

And this excludes consolidated inventory not owned.

Sequentially, our inventory during Q2 increased about $145 million from Q1.

At May 31, 2012, we owned and controlled 121,517 home sites, and had 440 active communities.

I'd like to turn it over to Jon.

Thank you, Rick, and good morning.

As Stuart noted, we're very pleased with our second quarter results of a post impairment 22.5% gross margin and 9.2% operating margin.

I will speak to how we continue to drive bottom line profitability through our management of pricing, product, direct cost and operating structure leverage.

Our operational focus of balancing sales, price and pace starts by first stabilizing pricing, community by community; then we focus on increasing the pace of sales, creating positive momentum.

It is this momentum that enabled us to lower incentives and/or raise prices this quarter.

This resulted in new orders of 4,481, improvements of 40% year over year and 48% sequentially over Q1.

For the prior four quarters, sales were stabilized at 2.4 sales per community per month.

This quarter, we increased our sales pace to 3.5 sales per month.

Incentives were down to 10.7%, a year over year 140 basis point improvement.

This was primarily due to the improved rate of sales and the higher percentage of homes sold prior to starting construction.

Our backlog grew to 3,970 homes, up 61% year over year and 46% sequentially.

With this rapid increase in our backlog, sold homes now represent 48% of total homes under construction.

That, combined with a material increase in the number of pre sold homes, we expect that our backlog conversion ratio will dip below 100% in Q3.

Our newer communities with higher gross margins and absorptions continue to capture a greater share of our deliveries and sales.

However, one of the keys for our margin and absorption success this quarter was our focus on communities where the rate of sales was below the Company average.

We have a process in place where our divisions review detailed plans with senior management on strategies and tactics to improve the performance of these communities.

Our product strategy continues to focus on the execution of our Everything's Included platform.

Having the right product with a simplified home purchase process gives us a competitive edge, especially against resales and rentals.

Our Everything's Included research has led us to introduce a new product line this year, Lennar's NextGen, the Home Within a Home.

We introduced this product in the West and are now rolling it out across the country.

We expect to be offering NextGen plans in about 25% of our communities by year end.

This home appealed to many buyer segments, but predominantly, the baby boomer who needs to take care of aging parents or boomerang kids.

This product is without competition from resales and is producing strong gross margins and incremental sales for Lennar.

This quarter, we continued to see urgency in customers making the buying decision, and raising prices helped create this urgency.

Sales were very consistent throughout the quarter, as only about 100 sales separated our biggest month from the smallest, and we are seeing continued strength into June.

On the mortgage front, we continue to face a challenging underwriting environment.

Offsetting this is our consistent and close working relationship with UAMC.

We see this benefit in our pre qualification process, which led to our low 16% cancellation rate.

Turning to the cost side of the equation.

While there are some cost pressures materializing, we continue to believe that these increases will be offset by sales price improvements and our continued focus on managing direct costs.

For six quarters running, our average direct costs remain in the range of $40 to $42 per square foot.

As I have discussed on prior calls, we have an intense focus on lowering our cost while improving our quality.

Our focus on Everything's Included not only delivers great value for the home buyer, but it allows us to simplify everything from how we order materials to the flow on job sites.

EI makes it easier to unbundle, giving us more transparency into our cost.

It allows us to reduce SKUs so our suppliers have less to stock.

And, with no structural options, value engineering is enhanced, because we do not have the need for multiple engineering solutions on each home.

All of this helps field labor, too, as there are fewer change orders and greater consistency in field installation.

We also continued our intense focus on managing extras and cost variances, working to eliminate these costs from the system.

With our increased volume we continue to leverage our operating structure.

With deliveries up 20% year over year, our SG&A dropped to 13.2%, a 170 basis point improvement.

Once again, our approach to simplifying the homebuilding process, centered around Everything's Included, enhances the overall leverage we're able to achieve.

We continue to be extremely disciplined in controlling our indirect cost.

We have in place a strong management team, organized in a simple regional and divisional structure, that allows for delivery growth with minimal additions to this structure.

Across our divisions we are actively and intensely managing each of the components that make up our net operating margin.

I want to add my thanks to all of our associates for their hard work and focus in achieving our second quarter results.

Thank you, and I'd now like to turn it over to Jeff.

Thanks, Jon, and good morning, everyone.

Rialto now has a focused team of over 200 professionals, acquiring, resolving and adding value to distressed and advantageously priced real estate assets.

We continue on the path to build a first class investment and asset management company, which over the long haul we expect will generate significant shareholder value.

This quarter's earnings of $4.3 million for the Rialto segment are still not where we would like to see them.

This is mainly due to the timing of recoveries and higher expenses resulting from a number of borrowers and guarantors in our earlier distressed debt portfolios taking obstinate positions about repaying their loans and bucking historical norms.

More recently, we have seen this turn into an increased effort by a number of investor and developer obligors to alter existing laws to frustrate the original contractual terms of the underlying loan agreements, specifically to limit our ability to collect what is due.

While we continue to be successful with our approach, including the use of the judicial process when necessary, the related higher costs must be expensed up front, while revenue recognition is being delayed until later in the process.

Nonetheless, operationally and from a cash flow perspective, we've made substantial progress on these portfolios, collecting over $650 million to date.

And we've already repositioned almost $2 billion of loans into owned real estate.

Of the original $627 million of FDIC seller financing, net of all cash on hand, it's now effectively down to approximately $240 million.

All of our distressed debt investments since early 2011 have been made through our Fund business, where we had already recalibrated our thinking about the timing and cost of resolution and we continue to materially exceed our original expectations on timing and amount of cash resolution.

Our first $700 million real estate private equity vehicle had another strong quarter, contributing $12.2 million from our share of underlying earnings, plus fees and reimbursements.

In addition, we have already started monetizing our investment in PPIP, selling almost $2 billion of face amount of securities since the last time we reported to you, and repatriating over $22 million to the Company of our $70 million investment.

Our Real Estate Fund has been able to acquire or tie up almost 40 different transactions and our pipeline of new investments continues to be strong.

We've already invested the lion's share of our Fund's original equity commitments to acquire about $1.8 billion of assets, based on unpaid principal balance, for less than $0.40 on the dollar.

And through the end of the quarter, the Fund has already collected over $225 million from interest, principal and asset resolutions at levels significantly higher and sooner than originally anticipated, as well as from a ground breaking non-performing loan securitization, which has received a great deal of industry attention.

Our Fund and future investment vehicles should not only help to enhance the Company's returns and add consistent cash flow and earnings, but also will be important building blocks for us to create a strong investment management business.

Along those lines, we're already earning fees from a number of sources, including the oversight of the fund in PPIP and from our loan workout and asset management activities.

We also earn carried interest when we exceed targeted returns.

In addition, last week we received our first rating as a CMBS special servicer.

We have already established Rialto as a leader in today's mortgage backed securities marketplace.

And for those of you who remember what we did with L&R, we expect these activities to open up new opportunities for us to add further to our existing book of business.

Perhaps the most significant and unexpected contribution that Rialto has added to the Lennar enterprise, though, is the invaluable access to borrowers and lenders that has contributed to the pipeline of deal flow that is driving our primary Homebuilding business.

As Rick and Stuart have indicated, direct access to distressed sellers has helped to source many advantageously priced land positions for the homebuilder.

Together, we have worked to add over 10,000 new home sites across dozens of new Lennar communities in multiple markets and with a lot more in the pipeline.

These are a few of the reasons why we remain excited about the continued progress of our Rialto franchise.

Our ability to add new sources of solid business on our already existing management base, our current position in the marketplace, and the synergies with the rest of the Lennar operations, we expect in due course will be reflected in growing value for our shareholders.

Thank you.

And David.

Thanks, Jeff, and good morning, everyone.

As Stuart mentioned, we reversed $403 million of our deferred tax asset valuation allowance in the second quarter of 2012.

We came to this conclusion because the Company determined that it was more likely than not that the majority of its valuation allowance against its deferred tax assets would be utilized.

The reversal of $403 million of our valuation allowance is presented as a benefit from income taxes in our income statement.

The conclusion to reverse this amount was based on a detailed evaluation of all relevant evidence, both positive and negative, including such factors as our nine consecutive quarters of earnings, the expectation of continued profitability, as well as the housing recovery we are experiencing in our markets.

I will take a few minutes to explain the process we undertook to reach our conclusion.

Historically, each quarter we have evaluated the relevant evidence regarding the DTA.

Our analysis each quarter included a review of the overall housing market conditions, local market conditions, and the Company's actual results and financial projections.

As of May 31, we concluded that there was sufficient objectively verifiable positive evidence that outweighed the negative evidence, and deemed that it was more likely than not that we would utilize our DTA in future periods.

And as such, we reversed $403 million of the allowance.

Among the factors we considered in our analysis were the following.

We have had nine consecutive quarters of profits, with an expectation of continued profits.

We were profitable across all of our businesses.

Our operating leverage has improved significantly.

Our year-to-date deliveries increased 24% year over year.

Our year-to-date new orders increased 37% year over year.

Our backlog increased 61% year over year.

Housing starts have increased and new home inventory is at an all-time low.

We project to use our NOLs in the carry-forward period, and we've had no history of NOLs expiring unused.

The process that we undertook to reach our reversal conclusion was extensive and was reviewed by our independent external auditors, Deloitte and Touche.

The reversal of $403 million of the DTA valuation allowance leaves a $177 million valuation allowance remaining at May 31.

There are two components that make up the remaining valuation allowance of $177 million, which, if the housing recovery continues, we expect most of the remaining allowance to reverse between Q3 2012 and Q4 2013.

The first component.

The accounting rules require valuation allowances being reversed in an interim period, such as our second quarter, to be partly applied to the remaining periods in the year.

Therefore, we expect to reverse portions of the $177 million valuation allowance in Q3 and Q4 of 2012.

These amounts should offset the tax expense we would have recorded in Q3 and Q4; thus we expect our net tax expense for the remainder of the year to be close to zero.

The second component.

We will also continue to provide a valuation allowance on a portion of our DTA relating to state NOLs.

The reason for this is that the state tax laws, for the most part, do not allow for us to carry back NOLs.

It's different for federal tax purposes, where we were able to carry back most of our federal NOLs.

We will evaluate the remaining amount relating to such state items each quarter, and if the housing recovery continues, it is likely that most of the remaining allowance relating to our state NOLs will reverse between now and the end of fiscal 2013.

With the reversal of most of our DTA valuation allowance, our stockholders equity is now over $3 billion, our net Homebuilding debt to total capital improved to 46.9%, and our book value per share is up to $16.79.

From an accounting standpoint, this is a significant milestone for our Company

And now, I'd like to turn it over to Bruce.

Thanks, David, and good morning.

I'll provide a little more color to the results, starting with Homebuilding.

Revenues from home sales increased 23%, to $796 million, driven by a 20% increase in wholly owned deliveries and a 2% increase in average sales price to $250,000.

The breakdown by region is as follows.

The East region had an average sales price of $231,000, up 4%.

Southeast Florida, $266,000, up 1%.

Central Florida, $229,000, up 9%.

Houston, $229,000, down 1%.

The West region, $304,000, down 1%.

And the other category, $321,000, down 17% due to product mix.

Jon already highlighted the drivers of our strong gross margin performance and significant operating leverage during the quarter.

The gross margins were strong in all of our regions this quarter, but they were strongest in the East and Southeast Florida regions.

During the quarter, we had asset sales that were recognized in both the equity and earnings from unconsolidated subsidiary and other income lines.

Although the joint venture asset sales resulted in a loss, the asset sales on the other income line had a profit, and combined, these two line items totaled $3.4 million of income in Q2, and that compares to $11.9 million in the prior year.

Our Financial Services business segment generated operating earnings of $18 million, versus $2.5 million last year.

These are the strongest quarterly operating earnings for Financial Services since 2006.

Mortgage pretax income increased to $17.2 million, from $5.3 million in the prior year.

This quarter's mortgage originations increased by 50%, to $976 million.

Our in-house mortgage capture rate of Lennar home buyers was 77% this quarter.

Originations with non-Lennar home buyers increased 89% this quarter, primarily due to an increase in the number of refinance transactions, as interest rates were under 4% for the quarter.

Our Title Company had a $1.4 million profit in the quarter, and that compares with a loss of $2.2 million in the prior year, as the volume of transactions increased by 39% this quarter.

Our Rialto business segment generated operating earnings of $4.3 million.

This number is net of $3.2 million of net earnings attributable to non controlling interest, and that compares to $9.8 million in the prior year.

The composition of Rialto's $4.3 million of operating earnings by type of investment is as follows.

The FDIC portfolios have a $3.2 million gain.

Non-FDIC portfolios had a $1.3 million gain.

PPIP contributed $2.7 million.

And the Rialto Real Estate Fund contributed $3 million of earnings, and that was all less by $5.9 million of G&A and other, which is net of management fees and reimbursements of $6.6 million.

Our balance sheet liquidity improved in the second quarter, with the completion of a $525 million three-year unsecured revolving credit facility, of which $410 million was initially committed.

As a result, our liquidity increased to $1.1 billion, when adding our cash balance to the fully undrawn revolver.

As David mentioned, our stockholders equity increased significantly this quarter, which reduced our Homebuilding net debt to total capital by 270 basis points.

And our book value per share increased 17%, again to $16.79.

While it has not been customary for us to provide earnings guidance, I wanted to highlight a couple of items for the remainder of 2012.

Our backlog conversion ratio, which has been running above 110% for the past few years, now with the large percentage of presales that Jon discussed and given the cycle time on these deliveries, a number of these homes will not close in the third quarter but rather in the fourth quarter.

As a result, the backlog conversion ratio we expect for Q3 deliveries is between 85% and 90%.

Additionally, we expect our gross margin percentage to range between 21% and 22.5% for the remainder of the year.

With that, let's open it up for questions.

We're now ready to begin the question-and-answer session.

(Operator Instructions) Our first question comes from Stephen Kim of Barclays.

Hello, guys.

I just wanted to first start off by congratulating you on a strong quarter.

I think that's a pretty impressive accomplishment.

Thank you.

I wanted to talk to you a little about your ability to raise prices as tempered by the appraisal process.

We've been hearing ongoing concerns about appraisals, and yet it does seem that just as buyers are able to get their financials in order in a better way than they were a year ago, builders are also finding ways to deal with a difficult appraisal process.

I was wondering if you could share with us what you're seeing in the marketplace.

Are you seeing any positive trends there, and what do you think it will take for the appraisals to take a significant step back in being a headwind for you?

Steve, we've discussed this topic, certainly at our President's meeting.

And, look, here's the good news.

The good news is that the appraisal process, appraisals in general, have really gotten in line with the market and the pendulum has kind of swung closer to normal than it was six months ago.

Six months ago appraisals just at market prices were really driving prices lower, and I don't -- we don't get the sense that that's as much the case out in the field today.

Now, with prices starting to move up, there's clearly some stickiness and there's going to be a process of kind of finding equilibrium and the appraisers getting a sense -- they'll probably lag the market and be a little bit more conservative in their approach, and we're hearing instances of this.

But over time, we think it's going to find its way to a realistic setting.

And I think, on average, I'd say I feel pretty optimistic about the appraisal side of things finding equilibrium maybe a little bit ahead of the mortgage side.

One thing I'd add to that, Steve, is procedurally in the field, we raise it in small increments.

So it's easier to get the appraisal to get there.

It's tough to goose things by $5,000 or $10,000 in a month period, so you break it up into $1,000 to $2,500 increments.

And we haven't seen a lot of resistance to that in the field.

Nor have I. That's a great change of pace from where we were a year ago.

Second question is, again, sort of a general question with respect to the issue of expectations.

You all were fairly early in identifying a turn in the housing market, at least in your communities, and we've seen increasingly people getting on board with that and echoing that.

I was curious, though, if there were any pockets of the industry where you felt that expectations are perhaps getting a little ahead of where the market really is right now and where you think it is reasonable to expect it to be in the next two, let's say, one to two quarters.

So areas where people, you sense, may be being overly optimistic at this point, maybe after having been a little slow to make that initial move, whether it be in the land side, in other areas of deal making, on the mortgage side, or anything that you're seeing in the marketplace.

Well, look, you highlight that we might have been a little bit earlier in reporting.

I think that we're just, as a management group very, very tightly connected with the field on a regular basis, and we're really just reporting very candidly the things that we're seeing, hearing and feeling as trends from the field.

I think that it feels to us that right now, as I've said, it feels very much like we've hit a bottom and we're starting to come off of that bottom.

I'm a little nervous about saying the word recovery.

We'll see how things evolve over the next couple quarters.

And it will be easy for people to get a little bit ahead of the market.

I don't think that there's reason for exuberance right now, except for the fact that the beatings have stopped.

But I think we do have headwinds in the market, whether it's mortgage approvals, whether it's kind of remnant limitations from appraisals and prices moving up.

I think that the -- it would be easy for people to kind of get ahead of themselves in terms of the high point of home prices and where they can go quickly.

I think that we're in for a steady recovery, as one takes hold, that is going to be slower than the V shape that people are used to, but at the same time, given the limitations on land, access to land, and land availability, we are going to see, as the recovery does start to take hold, a move up in prices.

So it's hard to say where people are getting ahead of themselves.

I think it's a little bit too fresh.

But I think that as in all recoveries, we are prone, as a group, to get a little ahead of ourselves.

We're trying to keep things in check and stay very closely tied to the field.

Okay.

Great.

Thanks a lot, guys.

Our next question is from Joshua Pollard of Goldman Sachs.

Hello.

Can you guys hear me?

Yes, we hear you.

Okay.

Great.

My first question was actually for Jon.

Can you walk through the progression of incentives per home by month over the course of the quarter and talk about where those incentive levels are in your backlog?

Ultimately trying to understand, even if you guys can't push prices because of appraisal issues, how much further you guys have to cut on the incentive structure.

Josh, first, we don't break out our incentives and backlog to that level of detail.

What we are seeing in the field is this recovery is very localized.

The downturn was very national.

But as conditions improve in the field, it improves at different levels in different markets.

In some markets, we've been able to both reduce incentives fairly aggressively and even raise prices.

In other markets, it's relatively flat and stabilized.

But we are seeing that trend come down, where a year ago we were about 12.5%.

A year ago, we were about 12.5% of average sales price in incentives, and now we're down to 10.7%.

We're seeing that steady decline.

I'd say that it varies by area.

In the West, we probably see about 85% of our communities are able to achieve price or incentive improvement.

In the Central, it's a little bit better than that; and on the East Coast, it's a little bit behind that.

Josh, are you still there?

All right.

Let's go ahead and move on to the next.

The next question comes from David Goldberg of UBS.

Thanks.

Good morning, everybody.

Good morning.

My first question, Stuart, you talked about in the opening comments your feeling that there was some in the government that kind of understood the issues around mortgage underwriting.

And I wonder if you could give us an idea of the political landscape in your mind now, between the forces that are kind of pushing for tighter underwriting, especially for FHA/VA loans, and the forces that say we need to kind of find a way to stimulate housing more through, at a minimum, don't tighten any more but maybe even loosen a little bit, and kind of your thoughts on how that's playing out, especially as it relates to the QM standard and underwriting as we go forward.

David, I'm not going to name names, but I will say this, that certainly within the government, there has been over the past year, a recognition and awareness that housing really is a central issue and key to a recovery within the economy.

And I think you see that really on both sides of the aisle.

It doesn't mean that there aren't some people that feel that more and more tightening is required, and you hear some of those sentiments come out.

But the more people have come to understand that housing is a very important key to driving employment and driving psychology improvements or sentiment improvement among the consumer, who by and large own homes, the feeling among many legislators is that the pendulum has swung too far and that the mortgage process has become overly cumbersome and been driven past the point of being safe and secure.

And there is beginning to be some pushback.

I think that if you were to speak to the people within Fannie, Freddie, FHA, VA, there's kind of a balancing point that kind of goes like hey, let's keep things conservative enough, let's not get back to zero down mortgages, let's have a healthy down payment; but let's also recognize that we've probably made the paperwork overly cumbersome, the credit scores, we're probably requiring too high of a credit score for what's reasonable.

And in order to get banks lending again, I think that there's a sentiment that we have to ease up a little bit.

Last thing I want to say is I remember last week it was that I saw an article that noted that the FHFA is starting to reconsider the put back requirements relative to some of the banks, as it relates to Fannie and Freddie loans.

That is a really good indicator that political currents are kind of moving in the direction of saying hey, if we can resolve or create safe harbors relative to put back risk, then we're going to define the landscape for banks and enable them to make a more comfortable lending decision as they go forward.

And I think that's as good of an indicator as I can point to that the political world is really starting to get an understanding that we've probably swung too far to the conservative side.

Got it.

Thank you.

And then just a follow-up.

I think you guys did a great job on outlining what differentiates Lennar on the land front, the land acquisition front.

And I was wondering if we could follow up and just think about the peer group that's also trying to pursue the same land opportunities, and if we kind of put Rialto to the side, because clearly that's a competitive advantage and very, very hard to replicate, I'm wondering about the other factors that you guys listed.

How replicable are they?

How much do you think you're going to see competitors trying to become, as an example, more nimble in the way that they're underwriting land to try to compete better with the likes of Lennar in the land market now?

In other words, how high are the barriers to entry right now?

How long will it take your competitors to try to do some of these things more efficiently?

Let's just be clear.

It is a very competitive land environment.

As you highlight Rialto as a distinguishing factor, keep in mind that Rialto has taught a lot of our Homebuilding divisions out here how to do these things in local markets.

So it's really Rialto almost on steroids right now in the markets across the country.

Things you need to think about is the DNA in Lennar has always been land-oriented, and we look at things in a different way than many of the other builders.

We're not averse to developing our own land or working with land owners to work on entitlements.

And as a result, we don't have a need to just go in there and buy finished home sites, because that's what our metrics are with regard to how we operate.

So from a process standpoint, we are very nimble.

We're fast.

We don't have an enormous book building process to get things reviewed at a local, then a regional, then a corporate level that takes three or four weeks or sometimes months.

We can make those decisions relatively quickly.

And with all that in mind, I think that speed is a huge differentiator, as well as the ability to do things that are extraordinarily complex.

Let me add to that.

There are two components of land acquisition.

Number one is finding the things to negotiate on and number two is the way that you go about negotiating.

I think it's very hard to just hire someone and to replicate.

I think that what you've seen in our management team, whether it's Jon and Rick on the Homebuilding side, whether it's Jeff on the -- Jeff and Jay Manse on the Rialto side, or Eric Feder as the bridge, so much of what we're able to identify is being driven by relationships.

Relationships that have been put in place over these past couple of years through the toughest of time.

And there's a certain thickness to those relationships that is sticky and is really positioning us well.

But a lot of what Rick highlighted, as well, is beyond just access to the deals.

It's the way that our group has reacted to those deals that augments the relationship and basically feeds back to it.

It's the speed at which we operate.

It's the completeness with which we deal with people.

It's the integrity that we bring to the table, and the decision to do the homework in advance and not end up retrading and walking away from a whole bunch of deals that is really holding us in good stead, as people look for certainty of close.

So my personal view is that it's not easily replicateable, and we're in an awfully good position right now.

Our next question is from Michael Rehaut of JPMorgan.

Hello.

Thanks.

Good early afternoon, I guess.

Nice quarter, everyone.

First question, on Rialto.

I know it's been, obviously, it's a segment that will not necessarily go in a straight line.

But you did mention you're not necessarily where you want to be in terms of the earnings out of there.

And I was just wondering if you can kind of walk through maybe where your, kind of reiterate, maybe get a little more granular in terms of the different buckets that you break out, where you're maybe having the most challenges, what you might be doing, if there's anything to do differently over the next couple quarters to maybe get that back on track ultimately to where you think it should be at this point.

I think the way that I look at it, Mike, is first of all, as we kind of segregate out or think through the component parts of Rialto, PPIP is performing very well.

Our private equity, or private investment fund, is performing extremely well.

The area where we've probably had the most kind of letdown is in some of our earlier portfolios, where I think Jeff highlighted well the fact that because -- really what you're seeing is moral hazard at work.

What we're seeing, and we have a long history of dealing with borrowers and distressed debt, what we've been seeing is that the borrowers have taken a more adamant, obstinate position in dealing with the workout team, and have almost just blocked the doors without any legal basis in coming or not coming to the resolution table.

In many instances, they've been hiding behind pending legislation from either friends or -- legislative friends, who they've engaged to try to get legislation to bail them out of what might be a bad contractual relationship or a bad personal guarantee.

And so the resolution process has been somewhat frustrated and stymied by a longer resolution period and some additional legal costs in getting to where we had expected to be in our initial diligence.

So timing is proving to be somewhat elusive.

At the end of the day, what we're finding is that the legislative attempts and the attempts of borrowers to subvert their notes and personal obligations is ultimately falling by the wayside.

And over time, we think that we're going to end up in the place that we thought we would end up.

But those initial deals are not performing timing-wise the way that we had hoped that they would.

Okay.

Just to take Rialto from the other side, because I believe you did mention that it is contributing to the core Homebuilding operations in a competitive, almost as a competitive -- as a competitive advantage, very much beneficial to the gross margin levels.

So on the flip side, I was hoping perhaps over this past quarter, the last couple of quarters, if you could give any insight in terms of I think you've done this before, what proportion of the land deals that you've entered into recently are through those more -- through the Rialto relationships where you have a less competitive or noncompetitive bidding process?

And when you look at the gross margin expansion that you've had, it would appear that most of it is just from lower incentive levels, but any insight around the contribution to the gross margins would also be helpful in understanding the other element of Rialto.

Look, I think this -- as I've noted, we've had some mild disappointments on timing relative to some of our earlier deals, but Rialto has been a grand slam home run for this Company, in terms of what it has done in terms of positioning us to be able to grow and enhance our primary Homebuilding business, not just from the standpoint of access to deals, because frankly that's gone both ways.

The relationships on the Lennar side have sometimes found new business for Rialto and sometimes very much in the opposite direction.

But the knowledge base that our Rialto team has enhanced our Homebuilding operations with, in terms of the breadth of kinds of deals that we can undertake to purchase in order to get to land, whether it's CDD bonds, as Rick points out, or purchasing notes on assets, or just having relationships with borrowers or people in the real estate business, we have leveraged the Rialto franchise as a very, very strong driver of Lennar business.

Now, disentangling and getting to percentages of deals that derive from the Rialto side, the Lennar side and what percentage has the Rialto relationship actually played, we just can't break it out that way, because it's kind of too organic.

It's intertwined.

And I've highlighted the work of Eric Feder as the bridge between the two operating divisions.

I mean, we have a very smooth and compatible relationship between both sides that's kind of amplifying the performance on both sides.

As it relates to the performance of Rialto going forward, we have absolutely put together a blue chip team of loan workout professionals that will be a platform for our business going forward, but we will recalibrated and get those operations working more in line with the way we expected in the beginning.

Okay.

Can I squeeze one more in?

If it's short.

Okay.

It looked like community count, given your sales pace, community count was down roughly 5% year over year.

Getting too long.

Can you give us a guidance of where you might end up for the year-end or what you think about 2013?

Community count?

Yes.

I think as we said in prior calls, from the beginning of the year we thought we would be up about 5% to 10% from the community count we started in the year.

On a net basis.

Thank you.

Thank you.

Our next question is from Alan Ratner of Zelman and Associates.

Hello, guys.

Nice quarter.

I was hoping to ask about your gross margin guidance.

I believe the high end of your range, 22.5%, is equal to what you guys reported this quarter.

And obviously, this quarter's results were much stronger than your prior guidance range.

And it seems, based on your commentary, you're having some success raising prices or reducing incentives.

And from Jon's comments, you've been pretty successful in mitigating the cost inflation you're seeing on the material side.

So just curious why you wouldn't make maybe a range a little bit higher than where you're currently at today and whether there's any other issues I'm missing here, either mix or something along those lines, that would offset some of those price increases.

This is Jon.

As I said in my comments, we do feel that we've got cost control measures in place that will help offset what's happening in the field with pressure on labor and materials.

We are very focused on incentives and sales prices.

But as you look forward, those factors are going to -- those pressures in the field, as starts increase, will continue to ramp up.

And it's very hard to predict with the mix and capital effect what that gross margin is.

And as we look to the different mix of deliveries from the markets changing in the forward quarters, we feel pretty comfortable with the range that we gave.

Okay.

Appreciate that.

And then on the corporate line, looks like there was a little bit of a sequential increase there, to about $29 million.

That's a bit higher than you had been running at.

Just curious if that's a function of the new markets you're entering or whether there was some one-timers in there, and where Rick may think about a run rate going forward.

Sure, Alan.

This is Bruce.

As you look at last year, the number was below normal.

I think we're averaging close to $24 million a quarter last year.

This year's $29 million, is primarily due to stock-based compensation expense, as the stock has gone up.

And some of the variable compensation expense also added to the G&A this quarter.

So that's something you expect to be recurring going forward, or depending somewhat on the performance?

We haven't given exact guidance, but I would expect as our profits go up, variable compensation expense will as well.

And as the stock prices increase, the stock compensation expense will also.

So I would expect it's likely to be higher than what you've seen in the past year, for those reasons.

Okay.

Thank you very much.

Our next question is from Stephen East of ISI Group.

Thank you.

Good morning, guys.

Stuart, if we could go back to demand just for a minute.

As we walk communities, we see where it looks like a lot of the new home sales are being helped quite a bit by lack of competing inventory.

And I'm just wondering, from your standpoint, whether you think that's true or not.

And then also, if that is true, are you starting to see it slide into, call it the B minus, C plus locations or any particular segment of demand out there?

Let me give that over to Rick and Jon.

They're a little closer to it.

Okay.

As far as the B, B minus, I think with the improving market, all communities are starting to perform a little bit better.

But clearly the better located A locations are capturing the lion's share of the activity.

We're seeing increased demand out there.

A lot of it has to do with the lack of availability of competing product, and that's given us the ability to raise prices and decrease incentives.

And as Jon said earlier, our sales pace per community, pretty much across the Company, has improved regionally and by each market.

This is Jon.

I think as you're aware, Phoenix is a good example of an answer to your question, where MLS listings dropped pretty dramatically.

That in turn helped the pace of sales and pricing for the new home product.

But as you get to the B minus and C locations around Phoenix, those are not doing as well.

So if you're down in Buckeye or Goodyear, they're not doing as well as Chandler and Scottsdale and the closer in markets.

I think we pretty much see that kind of scenario playing out across the country in the various markets.

Okay.

Thanks.

That's helpful.

And then if we look at -- you gave breakout of land spend, et cetera, and talked about community growth.

Are you de-moth balling the communities to any degree?

You've got a new revolver in place, so at what level are you comfortable with your cash balance?

So in other words, how do you look at land spend, et cetera, moving forward?

It's interesting, in our division President's meeting we went through each of our divisions, each division President gives a presentation, and we're very carefully monitoring the progress of moth-balled communities.

And the answer is yes, there are some that are starting to come online, and we actually have some pretty good examples of some that are really starting to contribute to our gross margin and bottom line.

Okay.

That's helpful.

One last quick question.

Are you seeing any shortages of labor in any of your markets, or anything along those lines that are pushing out your delivery date?

Just a little bit.

And it will -- it isn't all the trades, either.

But certainly, as is typical in market recoveries, sales go first, then starts and then labor has to catch up to that.

Okay.

Thanks a lot, guys.

Our next question comes from Robert Wetenhall of RBC Capital Markets.

Hello, guys.

Thanks for taking my question.

This is Desi filling in for Bob.

So regarding gross margins, you guys discussed sales incentives as a percentage of revenues were lower for the quarter.

The lowering of incentives, is that something you're seeing competitors do as well in the markets that you operate?

The competition, they're doing all sorts of things.

I think everybody in the industry's trying to raise prices and trying to reduce incentives.

And the success of our peers out there, I think you'll have to ask them with regard to what they're doing and how effective they are.

Okay.

And then for Financial Services, obviously, there was a big jump there in operating income.

And then in terms of the operating leverage in that segment, with the increase in new orders and deliveries, is that something you would expect going forward, how the operating could increase that greatly?

The operating leverage is there in Financial Services, just like we're seeing with Homebuilding.

I think the one thing to note is that there was a significant increase in volume, a lot of that attributable to refinance activity.

So the refinance activity will be certainly lumpier, depending what happens with interest rates.

Okay.

Thank you.

Our next question comes from Jade Rahmani of KBW.

Thanks for taking the question.

In looking at your operating margins, I wanted to find out how your incremental margin performance compared with the 16% guidance you gave last quarter.

We estimate roughly 30%, because you had gross margin expansion as well as the SG&A leverage.

Is that accurate?

And what do you think is achievable going forward in terms of incremental margins?

So again, just to go back to last quarter, what we said is in an existing community, when we go from two sales a month to three sales a month per community, the incremental operating margin is about 16%.

And that was assuming the 21% gross margin and then the incremental SG&A expense of about 4.5% or so.

So that type of incremental leverage was a little bit higher this quarter as the gross margin was a little higher than the 21%.

So we still believe the incremental operating leverage in existing communities to be at about that level or possibly a little bit higher.

In new communities, it's a little bit less, because the SG&A expense is a little higher.

You have to hire sales and construction people, bring on new models.

And there, we typically say that the SG&A incrementally is 7% or 8%, so your incremental operating margin will be a little bit less.

So we do expect that incremental operating leverage to continue.

Okay.

So margins, as your volume increases, margins should still expand.

Secondly, just on the backlog conversion guidance, the lower spec -- is the lower spec mix a function of the market or a change in your strategy.

And then secondly, are you intentionally constraining delivery pace in order to both manage your margins as well as control construction and labor costs?

First of all, I don't think that we're managing our deliveries.

I think that we've highlighted that we're very focused on generating strong margins, and so we've had a very measured approach to both sales and starts.

I highlighted in my remarks that looking -- watching our gross margins, you're seeing that we have a very carefully programmed approach to pricing our product, making sure that we're maintaining margin, so this has been something that's been consistent over the past years.

In terms of what is affecting our backlog delivery ratio is the fact that we are -- we've seen a fairly aggressive strong move in sales.

We are probably selling a higher percentage right now of unstarted homes, of homes that will have more cycle time remaining in them.

So as we face the third quarter deliveries, we recognize that we're simply not going to be able to deliver as high a percentage of the backlog.

And this is just what we're seeing as we sit here today.

Why don't we go ahead and take one more question.

Our next question comes from Jack Micenko of Susquehanna International Group.

Good afternoon, guys.

This is John [Bend] on for Jack.

I just had a couple quick questions for you.

First is that, with our regional bank coverage, we're seeing increased mortgage repurchase reserving.

I'm just wondering if you guys saw any of those trends in your Financial Services unit in the quarter.

No, we did not see any significance there, no.

So no new aggressiveness that you're seeing.

And then as a follow-up with the DTA reversal, I know you listed about eight factors.

Was Lennar's cumulative loss position a big consideration in the valuation allowance reversal, or was that not looked at or just not given much weight?

The cumulative loss is something that is evaluated, but we're still in a cumulative loss position.

So there has to be significant positive evidence that comes into place, and it has to be significant while you're still in that cumulative loss position.

So that was taken into account, but there was enough positive evidence that allowed us to reverse the DTA.

Great.

And was there a PPIP mark in the quarter?

It was negligible.

It was a few thousand dollars.

All right.

Thanks a lot, Bruce.

Sure.

Very good.

We'll wrap it up here.

I know that we took a little bit long with our opening remarks, but we wanted to cover a lot of ground.

We certainly appreciate everybody joining us for our second quarter update and look forward to reporting our quarter in the third quarter.

Thank you.

This concludes today's presentation.

Thank you for your participation.

You may now disconnect.