Lennar Corp (LEN) 2014 Q1 法說會逐字稿

Welcome to Lennar's first-quarter earnings conference call.

(Operator Instructions)

This conference is being recorded.

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

I would now turn the call over to David Collins for the reading of the forward-looking statement.

Thank you, and good morning, everyone.

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 affect future results, and may 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 in this morning's press release and our SEC filings, including those 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.

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

Sir, you may begin.

Good morning, everyone.

Thank you for joining us for our first-quarter update.

This morning I'm joined by Bruce Gross, our Chief Financial Officer; Dave Collins, who you just heard from; and Diane Bessette, our Vice President and Treasurer.

Additionally, Rick Beckwitt is here with me this morning, who is our President, and Jeff Krasnoff, Chief Executive Officer of Rialto, will join in for the Q&A session.

We also have Eric Feder here who facilitates our deal flow across our operating platforms, and whose birthday it is today, and he will join us for Q&A today as well.

Happy birthday, Eric.

And Jon Jaffe is available by telephone; he's our Chief Operating Officer and he is in California.

As is customary on our conference calls, I want to begin this morning with some brief overview remarks on the housing market, and then briefly overview our operations.

And then Bruce is going to provide greater detail on our numbers, and some additional comments on financial services segment.

And then, as always, we'll open up to Q&A.

As in the past, we would like to request that during the Q&A session, each person limit themselves to one question and one follow-up.

So, let me go ahead and begin.

And let me begin by saying that we are very pleased to report that we've been able to begin our 2014 year with a solid first-quarter start.

Our Company is very well positioned to be able to continue to perform extremely well due to our well-crafted strategy, and tied to a clear view of general market conditions.

In our year-end and fourth-quarter conference call, we reported to you that we had seen a clear pause in the rate of recovery in the housing market.

And while prices had continued to appreciate, volume had clearly subsided.

In the first quarter, we have seen clear signs that volume is returning to the market, even as severe weather made conditions difficult.

As we moved past the seasonally slowest months of the year at year end, we began to see both traffic and sales volume begin a steady month-by-month improvement throughout the quarter.

The progression through our fourth quarter of 2013 and into our first quarter of 2014 continues to fuel our confidence in our belief that the housing market recovery continues as we begin to enter the more vibrant seasonal months of the year.

We continue to believe that the fundamental drivers of improvement in the housing market remain a steadily improving economy with a slowly improving employment picture unlocking pent-up demand, while supplies remain constrained to meet that demand.

We continue to believe that there remains a production deficit of both single-family and multi-family dwellings from underproduction during the economic downturn, and up to and including last year.

This shortfall will continue to define the housing markets for the foreseeable future, and will drive the housing recovery forward.

Accordingly, the builders of both multi- and single-family products will continue to increase production, as inventories have remained extremely low, and pent-up demand comes to the market.

And even as the market responds, inventories are likely to remain constrained as production increases are limited by a shortage of entitled and developed land to build on in desirable locations.

While we recognize the potential headwinds from a constrained and sometimes uncertain mortgage market, including interest rate volatility, and sometimes volatile consumer confidence, and also diminishing investment purchasers in the resale market, we feel that the fundamentals of short supply of available homes and pent-up demand will continue to define our strategy of land acquisition and growth, and drive the recovery forward.

Against that backdrop, Lennar has begun 2014 with very solid first-quarter results, as each of our businesses showed strong performance in the first quarter, and are well positioned for the future.

This speaks both to the solid management execution of our articulated strategies, and to the positioning of our Company for continued performance throughout the year.

Now, homebuilding, of course, remains the primary driver of our quarterly performance.

For the first quarter, homebuilding revenues grew to $1.2 billion, up 42% over last year, as we continued to focus on maximizing pricing power.

Deliveries were up some 13% over the prior year.

Our sales pace in the first quarter averaged 2.8 sales per community per month, which was essentially flat compared to last year.

We opened 60 new communities, and closed out 49 during the quarter, to end at 548 active communities, which is a 13% year-over-year increase.

And our absorption pace and sales improved sequentially through the quarter, with the sales in the quarter up 10%, while new-order dollar value was up 26%.

In the west, where we were not impacted by weather, and where we were able to open new communities, our sales were up 45% year over year, and 47% on the community count growth.

Our western operations made up for some of the markets that were hardest hit by severe weather conditions during the quarter.

We continued to focus on maximizing our pricing power.

Our average sales price of $316,000 was a year-over-year increase of $47,000, or 18%, and a 3% sequential increase from the fourth quarter.

This improvement in sales prices covers our increases in labor, materials, and land costs, improving our gross margins by 300 basis points to -- 300 basis points year over year to 25.1%.

Year over year, labor and material costs are up 9.8% to over $47 a square foot, and sequentially this is less than a 1% increase from the fourth quarter, as lower lumber prices from previous quarters were reflected in this quarter's results.

We continue, however, to see cost increases in some of the material, most notably, drywall, lumber, and siding, that will begin to impact our second-quarter deliveries.

However, we did see an easing on the labor pressure in many of the markets.

With SG&A of 11.8%, we continued to improve our operating leverage, as this is a 20-basis-point year-over-year improvement.

This operating leverage, combined with our pricing power, produced a 13.2% net operating margin for the quarter, which is a 310-basis-point improvement year over year.

We have continued our focus on cost-effective marketing, with total Lennar online visits in Q1 increasing 39% year over year, and this quarter we also surpassed over 1 million social media followers.

I'd like to also point out that our bottom-line performance has greatly benefited from the execution on our Next Gen product strategy.

Year over year, sales of our multi-generational brand grew by 57%, and accounted for 5% of our new orders in Q1.

We now offer our Next Gen plans in 178 communities across the country, and in Q1, the average sales price for Next Gen was about $450,000.

During the fourth quarter, we continued our carefully crafted land-acquisition program, and purchased approximately 8,800 home sites for $505 million, while we spent $226 million on land development for the future.

Combined, our land-acquisition and land-development spend was up about 33% over the prior-year period.

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

At quarter end, we owned and controlled approximately 154,000 home sites, and as I mentioned before, had 548 active communities.

As we noted in our last conference call, we expect to be able to increase community count by approximately 15% over the course of 2014.

As we look ahead to the remainder of 2014 and beyond, we are fortunate to have land in hand to meet our projected deliveries through this year and for all of next year.

And this positions us very well to maintain gross margins that are consistent with our reported first-quarter margin for the remainder of the year.

Our fourth-quarter performance highlights very strong management execution, but also indicates how well positioned we are for future performance, driven by a strong operating strategy complemented by an excellent management team and excellent management execution.

Complementing our homebuilding operations, our financial services segment continues to build its primary business, alongside the home builder, and is working to replace the now diminished refi business with a vibrant retail business across our national footprint.

Bruce will talk more about our financial services progress, which had a very [respectable] quarter, with operating earnings of $4.5 million, though down from the $16.1 million last year when the refi business was thriving.

While our homebuilding and financial services division are the primary drivers of near-term revenues and earnings, our three additional operating divisions are all continuing to mature as excellent longer-term value-creation platforms for the Company.

Rialto continues to make significant progress in transitioning from an asset-heavy balance-sheet investor to a capital-light investment manager, commercial loan originator, and securitizer.

Rialto today is involved in three different businesses.

Our first is the direct investment business, where we were able to return, or will return shortly, over $120 million in cash to the partners in those initial investments, including almost $50 million to Rialto.

Our goal is to monetize the bulk of these assets by the end of 2016, generating over $400 million of cash for us to recycle.

The second area is our growing investment management and servicing platform.

Our objective here is to grow our assets under management and create value for investors.

We're continuing to build upon the base established with our first real estate fund, and during the quarter we completed the raise for Rialto Real Estate Fund II, closing out with $1.3 billion of equity commitments.

And Fund II is already invested, or committed to invest, approximately $700 million in approximately 50 transactions, and has started making distributions of income to investors as well.

We expect to begin raising our third real estate fund later this year.

Finally, our third business is Rialto Mortgage Finance, our high-return-on-equity conduit lending platform.

RMF, as we refer to it, is focused on originating and securitizing long-term fixed-rate loans on stabilized cash-flowing commercial real estate properties.

During the first quarter, we completed our fifth and sixth securitization transactions, selling an additional $250 million of RMF-originated loans, bringing the total to almost $1 billion in only our first two quarters of securitization activity.

In the first quarter, Rialto exceeded our break-even expectation with a $2.6-million profit, and is well positioned for a strong 2014.

As with Rialto, we're very pleased with the progress of our multi-family apartment business.

As we've noted in the past, this business began operations in early 2011, and is positioned to be one of the leading developers of new class-A apartments in the United States.

As home ownership rates have drifted downward, and the large millennial generation begins to leave home and form households, this strategy continues to be an excellent complement to our primary for-sale homebuilding business.

During the first quarter, we started development and construction on three additional apartment communities.

We now have 15 communities, of which 2 are completed and operating, and 2 are partially completed and leasing; and the remaining 11 are under construction.

These 15 communities have approximately 4,000 apartments, with an estimated development cost of approximately $835 million.

In addition to these communities, we have a geographically diversified pipeline that exceeds $2.8 billion, and represents an additional 11,600 apartments.

As we've discussed in the past, we are building these apartments with third-party institutional capital, and each deal has been conservatively financed with non-recourse debt.

With our conservative financing and our conservative underwriting, we are positioned to earn IRRs exceeding 25%, and cash multiples greater than 2 times.

We anticipate that the construction of our development pipeline will be completed over the next four years.

Finally, our FivePoint Communities program continues to mature as a long-term strategy as well, and is quickly moving to bring developed land in our premium California locations to the market to fill the growing demand for well-located, approved and developed home sites.

Overall, and in summary, our Company is extremely well positioned to succeed in the current market conditions.

We have an excellent management team that's focused on a carefully crafted strategy that has positioned us with advantaged assets that will continue to drive industry-leading profitability.

Additionally, we have a well-diversified platform that will continue to enhance shareholder value as our ancillary businesses mature.

We're very pleased with our progress and performance in the first quarter, and we look forward to reporting progress on a very successful 2014 year ahead.

With that, let me turn it over to Bruce.

Thanks, Stuart, and good morning.

Our net earnings for the first quarter were $0.35 per diluted share, versus $0.26 in the prior year.

Our earnings before income taxes were $126 million, which was an increase of 136% over the prior year.

I'm going to add a little color to the numbers starting with homebuilding.

The 13% increase in deliveries resulted in a backlog conversion ratio of 75% for the quarter.

This was within our previously announced goal for the quarter, despite the tough weather conditions that Stuart mentioned.

The 18% increase in average sales price to $316,000 is broken down by region as follows.

The east region was $279,000, up 11%; southeast Florida was $341,000, up 26%; central region was $266,000, up 3%; Houston was $278,000, up 8%.

The west region was $413,000; this was up 41%, and although they had a sizeable increase in average sales price, they also benefited from some favorable product mix.

The other region was $385,000, up 13%.

Our gross margin on home sales, which Stuart highlighted, was up 300 basis points to 25.1%.

This improvement was driven by a couple of things.

Sales incentives were $21,300 per home in the quarter, and that was a year-over-year improvement of 170 basis points.

It came down from 8% in the prior year to 6.3% as a percentage of the home price.

The gross margin percentage improved in the east, southeast Florida, Houston, and west regions during the quarter, and the highest gross margin was in the southeast Florida region.

Additionally, during quarter, we received an insurance settlement totaling $5.5 million, which favorably impacted the gross margins.

In addition to the significant operating leverage mentioned earlier, we have additionally recognized operating leverage in our corporate G&A line, as our corporate G&A improved 40 basis points to 2.8%, and this is as a percentage of total revenues.

During the quarter, we closed $91 million of land sales, totaling $16 million of profit.

$65 million of these land sales were from mothballed assets, which were strategically sold to redeploy the capital into nearer-term producing assets with favorable operating margins.

Additionally, in one of these sales, Lennar will be the developer and will earn approximately $7 million in fees over a two-year period starting in 2015.

Our ending community count increased to 548; however, there were about 16 communities that were shifted into Q2 as a result of a delay due to weather conditions.

Turning to financial services: This segment generated operating earnings of $4.5 million, versus $16.1 million in the prior year.

This is in line with our year-end conference call comments that we expected financial services earnings to be below $5 million for the first quarter.

Mortgage pre-tax income decreased to $6.5 million from $16.4 million in the prior year.

The decrease in profitability was primarily due to an 83% decrease in refinance loan origination volumes, which also resulted in margin compression, as more competitors focused on the purchase business.

Mortgage originations declined 25% from the prior year to approximately $900 million, and we captured 75% of Lennar home buyers using mortgages for their purchase.

Our title companies also experienced a significant reduction in refinance transactions, and in this quarter, which is the seasonally slowest quarter of the year, they had a $1.6-million loss, compared with a $300,000 profit in the prior year.

Turning to the Rialto segment: They generated operating earnings of $2.6 million, compared to $1.7 million in the prior year.

Both of these amounts are net of non-controlling interest.

The composition of Rialto's operating earnings by the three types of investments are as follows.

The direct investments, which is the FDIC and bank portfolios, had a net loss of $1.6 million.

The investment management business contributed $5.8 million of earnings.

And these numbers don't include the carried interest, which, under a hypothetical liquidation, increased by $9 million for the quarter, and is now at $90 million.

We expect this number to continue to grow, and isn't recognized as income until proceeds are actually received.

Our new Rialto Mortgage Finance operations contributed $253 million of commercial loans into two securitizations, resulting in earnings of $3.1 million for the quarter, and this is net of their respective G&A.

Additionally, there was [$1.1] million of management fees, which is net of remaining Rialto G&A and other.

Interest expense for the quarter increased to $5.7 million due to the issuance of $250 million of senior notes in the fourth quarter.

And the Rialto balance sheet is very well positioned today.

They ended the quarter with $169 million of cash; and subsequent to the quarter end, we completed a $100-million add-on to the initial $250-million five-year unsecured notes that we closed at the end of last year.

This add-on was done at an effective interest rate of 6.31%.

The multi-family segment results for the quarter are consistent with expectations, as we have net start-up operating expenses of $6.2 million.

Our balance sheet liquidity is strong.

We ended the first quarter with $646 million of homebuilding cash and no outstanding borrowings under our $950-million unsecured revolving credit facility.

We issued $500 million of senior notes due June 2019 in the quarter.

This reduces our borrowing cost, and also fits well into our debt maturity ladder.

Our homebuilding net debt to total cap was 48.5%, and we received positive outlook upgrades from both S&P and Moody's during the first quarter.

Our book value per share at the end of the quarter increased to $20.84.

Finally, let me summarize what we've said on this call, and revisit the 2014 goals from our year-end conference call.

First, with deliveries, we are maintaining our goal to deliver between 21,000 and 22,000 homes for 2014.

We are also maintaining our backlog conversion ratio expectations, which is between 80% and 85% for both Q2 and Q3, and we expect to be over 90% for Q4.

Next, our gross margin expectations are to still average 25% for the full year, with the fourth quarter being higher than the second and third quarter of this year.

Our first-quarter gross margin percentages were benefited by approximately 50 basis points due to the insurance settlement highlighted earlier.

SG&A: We continue to focus on leveraging this line, and expect about 25 basis points of potential improvement throughout the year, same as we said at year end.

Financial services earnings are still expected to be in the $65 million to $75 million range for the full year, and it's more heavily weighted to the second half of the year.

Rialto still expects profits between $30 million and $40 million for the year, and those profits are also more heavily weighted to the second half of the year.

Multi-family still expects start-up losses of $15 million to $20 million for the year, and this includes one or two apartment community sales that are possible later this year.

Our joint venture and land sale category: We do not expect any significant sales for the remainder of the year, so we expect to be about breakeven for these two categories.

And our 2014 effective tax rate is now expected to be about 37%.

Net community count for the year: We still expect to end the year in the range of 600 to 625, even though we had a delay of about 16 communities into our second quarter.

So, with that, let me turn it over to the operator for your questions.

(Operator Instructions)

Our first question is from Ivy Zelman with Zelman and Associates.

Go ahead, your line is open.

Good morning and happy birthday wishes to Eric.

Big picture, Stuart you have a very solid quarter and you talked about the sequential improvement in pricing.

Can you talk a little bit about the competitive environment and any change in your view of builders increasing incentives as they're not seeing sales pace and how it impacts your business?

And then just on a bigger picture basis, you'd highlighted that your current operating divisions, I think you had said are at roughly 30, and the comparison I think was over 100 at the peak.

How do you operate as you grow with such a lean infrastructure, and is the opportunity to improve SG&A significantly better than where you are today?

Ivy, I'm going to let Rick and then Jon weigh in on those two questions.

From a competitive standpoint, Ivy, the market has heated up a little bit, partially driven by the fact that there were some weather issues and builders were trying to move inventory close to the end of their quarters, depending on where their quarters were.

And we're benefiting from the fact that there's not a lot of inventory out there for sale, so the issues aren't that pronounced at this point.

We did not increase significantly any incentives throughout the quarter, as you can see in our numbers, although there are some folks out there that are pushing the number in order to move some inventory.

We're not alarmed by that.

We think that our communities are really well located or in decent places.

We've got a good mix of build jobs as well as things moving through the construction cycle, so we're really pleased with where we have inventory and how things are priced.

We have seen a little bit of slowdown in price increases as we've moved through the year.

Prices ran real quick, and so to the extent that there are incentives, it's sort of a balance between maybe not moving the price up as much as taking something away.

Jon, your thoughts?

I would echo what Rick said.

There are some isolated cases where competitive incentives are kicked in, and particularly if you're looking at Phoenix or Las Vegas, but we're well positioned and we're focused on really margin over maintaining a pace where there might be those incentives.

For the most part the West has been relatively light in incentives, because it's so land constrained.

If you look at the West, it hovers around 3% as compared to the Company average of just over 6%.

We feel that we're very well positioned as we move forward with our community locations, product type.

And as well, I'd add our EI platform gives us a differentiation that allows us to, I think, hold our prices more stable.

With respect to the growth in leveraging the way we structured our divisions, I think we learned a lot during the downturn and are very well positioned to be able to leverage that and continue to grow our community count with adding very little in the way of division management.

We'll clearly add out in the field in construction and sales as we add community count, but we see the need to add very little in terms of additional operational groups to be able to grow year over year effectively.

And just to add to that Ivy, from an organizational standpoint, keep in mind, we at the peak of the market were running this thing with nine regions.

We've got four today.

We had 100 plus operating divisions, and while we're at 30, as some of the markets get a little bit bigger, let's just use South Florida, we're probably going to split South Florida into two pieces because it's gotten so large.

But given the fact that we've structured this pretty efficiently with product strategy and where things are getting purchased from a regional standpoint, we think we can keep the overhead real well in control, and get some operating leverage.

Let me add one more point here, and that is as we went through the downturn, we consolidated divisions in a number of ways, we combined some geographies, some of those geographies will be unbound.

But we were also running dual platforms in almost every market.

We were running an everything-is-included in a design studio platform across the country.

And it was really a pretty inefficient way of running, but hard to unwind while the market was heated.

The downturn in the market really enabled us to unify under a single platform, we today have a well crafted EI program that is adapted to each local market.

Rick and Jon work together and across our platform to really carefully craft the strategy as a one division market strategy for each unique geography.

And that marketing platform is very efficient today.

So while there will be some unwinding of some of the geographic doubling up, it will be minor in comparison to the efficiencies that we've created by operating under a singular platform that's really carefully crafted for each market.

Great, thank you very much.

(Operator Instructions)

Our next question is from Eli Hackel with Goldman Sachs.

Thanks, good morning.

Stuart, I know historically you've said credit is loosening, but maybe very, very slowly, and it will take some time before we look back a couple years and see that action.

It seems to me the biggest hurdle is regulatory uncertainties, so maybe what specifically are you doing and maybe a little bit about what the industry is doing as maybe to get up on Mel Watt or whoever else could potentially get us some more regulatory certainty in the market, maybe not such big things as GSE reform, but maybe some other things on the margin that the industry could potentially do to get things moved on a little more quickly.

I'd love your thoughts on that.

Yes, well it's a good question, and let me say first of all that the industry is not just working on and getting in front of Mel Watt, but all of the participants in the discussion, both in Congress and the Administration, and making sure that we are heard and that the pitfalls of rapid change if not carefully thought out, but doesn't properly regard the plumbing system that's in place, should be of great concern.

So when I say the industry I'm included in that, but most of the CEOs are working together within the industry to make sure that the industry's voice is heard.

So what are we doing other than trying to make sure our voices that are heard?

I think a lot of the same things that investors and analysts and others are doing, and that is we're going to have to wait and see what actually does shake out.

I know that we've seen some initial readings from the Senate's, I guess, finance committee or banking committee that's already approved GSE reform in a sense, but it's a long way until those reforms are adopted by both Houses of Congress and actually moved forward.

A lot of people think that there might not be much movement this year and maybe not for a couple years, we'll have to wait and see.

What we have seen though in the field is that at the margins credit has been reverting to more normalized levels in a very slow kind of orderly fashion.

I will say that mortgage approval and tight money is a constraint to opening up demand and bringing demand to the marketplace, but at the margins and over time I think we are seeing that reversion to normal.

So you kind of have to sit back and rely on the fact that the Administration and Congress understand how vital housing is to economic recovery and rely on the fact that they probably won't do something that materially alters the landscape and we'll continue to see that reversion to normal as we go forward.

That's kind of how we're thinking about it and incorporating that thinking into our business strategy.

Great, thanks.

And maybe just one quick follow-up.

Just curious about how you view your ability as one of the only companies to grow substantially in the West, how you're able to do that.

And then quickly just curious about the South Florida decline there, maybe that was just community count driven, but was curious on that.

Thank you very much.

Okay, on California, Jon, why don't you weigh in and Rick why don't you take the East.

Sure, hi, Eli.

In California and the West in general, we got out early and aggressive as we talked about on prior calls with our land acquisition strategy and positioned ourselves for strong community count growth year over year, 2013 over 2012, 2014 over 2013, and where we sit today we're well positioned into 2015 and 2016 and even into 2017.

So it's really been that strategy of getting out in all of the primary markets in California, acquiring some flagship communities to have a stable presence in a lot of the markets, and then adding on to that and position ourselves for that significant kind of growth that you've seen.

So enabled us to increase our sales activity 45% in the West and sales price up 37%, and that's on that community count growth of 47%.

And we see that growth not staying at the high level of community count, but significant as we move forward.

And with regard to Southeast Florida, that's really been a conscious effort on our part, we did not want sales to get ahead of us.

This is a very strong market here.

We've been very focused on pricing, you saw during the quarter we were up about 9% in South Florida on pricing.

A little bit of it had an impact with regard to the timing of some grand openings that we had last year, particularly in the Doral area.

But we're very comfortable with the strategy that we're executing here.

It's one of the -- it's the market that has perhaps the highest margins that we have in the country, we've got great land assets and we want to make sure that we don't build through them too quick, and building up backlog if we can't deliver them doesn't make a lot of sense for it so we slowed it down.

Great, thank you very much.

Our next question is from Michael Rehaut, with JPMorgan.

Go ahead, your line is open.

Thanks, good morning everyone.

Good morning.

First question I had was on sales pace and I think in the press release, it was noted that still maybe a little bit too early to call the Spring, but at the same time obviously we're about a month and a half in, February obviously contributed to a solid quarter and you have an early look on March.

With the comments also about sales pace I guess improving sequentially throughout the quarter, I was curious if you could give us a sense of -- on a year-over-year basis sales pace was down roughly 4% versus the year-ago quarter.

If that was different at all intraquarter, and as you kind of with the momentum I guess or of at least February and into March, if there's any additional comments you might want to provide about your comfort level or confidence about the next couple of months.

Yes, so Mike, we haven't gone through the monthly absorption rate.

What we did highlight is that we did progress favorably through the quarter.

We were pleased as we got into February, but we didn't get to the specific absorption rates month by month.

But we're optimistic with what we're seeing with traffic.

Traffic improved throughout the quarter as well.

Again, not to drill down into the numbers exactly.

We felt like this is a normal progression through our first quarter going into the Spring.

We haven't commented on March.

We typically don't give intraquarter commentary, but this is a normal progression that we would expect going into a Spring selling season and we'll wait and see what happens for the next three months.

Okay, I appreciate that.

I guess the second question just on gross margins, not to nit pick too much, but just so more that I just understand correctly your comments earlier, Bruce about fourth quarter, you expect fourth-quarter gross margins to be better than I believe you said 2Q and 3Q.

Obviously with the first quarter coming in around 25%, it might imply 2Q or 3Q being a little bit less than that.

I just want to know if I'm interpreting that correct?

And I know you haven't really talked about margins beyond this year, but given the high level of margins relative to history, at the same time you have a great backlog of land that might create some above-average visibility or sustainability of those margins, how you guys are thinking about margins past 2014.

Okay, so let me start with the first part of that question.

In the first quarter, just a reminder we had the benefit from the legal settlement, so excluding that we were at 24.6%.

We expect Q2 and Q3 to be a little bit higher, and therefore, it would likely be below the 25.1% if you included the legal settlement, and then the fourth quarter would likely be higher.

So look at the 25% without the legal settlement included.

And then for the second part of the question, we haven't given any guidance to next year yet, but we do feel really good about the land.

As Stuart said earlier, we do have locked and loaded the land for this year and next year.

We feel very comfortable with the efficiencies we have in the business.

So there's no reason to think that there's going to be a fall off in the margins at this point.

We'll continue to update as we go through the year, but we're very encouraged and enthusiastic as we think ahead into next year.

Just to add to that, let me say, as we look ahead to 2015 and 2016, Mike, we've articulated in prior conference calls that we are thinking about volume.

Remember that this recovery has been somewhat different than prior recoveries in that it is -- we've led this recovery with price increase recovery as opposed to volume recovery.

But as we go forward, we suspect that we're going to see volumes increase, and it's altogether possible that as volumes increase we will add, shorter-term, more retail-oriented positions to our land portfolio.

And as we do that, that could alter the landscape of margins going forward; that is gross margins in favor of operating margins as we leverage our platform.

So we're not going to look too far ahead.

Right now, we have a great deal of confidence in our margin composition and where we're going in 2014 and into 2015, but the complexion of that can change and be altered a little bit if we decide to pick up volume by adding some community count.

So we don't really want to give a firm projection, but do want to highlight that we have excellent land positions to carry us into next year.

Very fair.

Much appreciated.

Sure.

Our next question is from Stephen East with ISI Group.

Go ahead, your line is open.

Thank you, good morning, everybody.

Stuart, you all gave us a lot of good information on multi-family, Rialto, et cetera, and we should be able to start to unlock the value a little bit more from a modeling perspective.

As you sit and look at those businesses and the timelines for monetization, you talked a little bit about potentially selling one or two apartments, but as you all think internally, how do you start to unlock the value from a monetization standpoint and when do you think that starts to occur?

Well as I noted, Steve, these businesses are maturing and maturing right on track.

When you look at the apartment business, you really are starting to see a business that is defining kind of a recurring program, though we're not quite there yet.

Right now, we have 2 communities that are completed, 2 communities that are partially completed, and 11 that are under construction.

As we look ahead, we are pretty confident that we'll start construction on another seven or so this year, and maybe even more.

As we start to develop kind of a monthly tracking mechanism and a way of thinking about how long it's going to take to actually put something online, take it off-line, and monetize, that's where we're going to start to be able to bring visibility to you as the business matures, and more importantly, start to think about what kind of monetization program might be most efficient in creating shareholder value.

Likewise, Rialto is starting to present itself in a more normalized way.

We highlighted three business segments, it's actually really two.

The first business segment is the liquidation of our legacy assets; the other two businesses are really starting to perk up and present.

The asset management business is really fortifying itself with assets invested that are starting to generate real returns, and perhaps more importantly, promote that is not yet realized.

And as that starts to get realized, the maturity of that business will present itself alongside of RMF, which is our make-loans and securitized business, which is basically a fee business based on volume.

So over the next year or two, we'll really start to see some visibility come out of those businesses, and that visibility will be a stepping stone to getting to some form of monetization.

Okay, thank you.

And then just going back to the core business just sort of looking at it, as you talked about this year, you've highlighted to some degree that you've got a little bit of SG&A leverage, but when I listen to Rick and Jon, it sounds like the potential for SG&A leverage could jump up quite a bit if you can get the volumes through the 15%-type growth on communities.

Just where -- when you all think about your business, are you basically there on SG&A leverage?

Or is this a story that's a multi-year and we can expect to drive levels at maybe lower levels that we didn't see in prior cycles?

This is Rick.

I don't think we're there quite yet, but it's coming pretty fast.

We were a little bit delayed on the quarter because we had some weather impacts, new community openings as Bruce highlighted, starts were a little bit impacted by 100 to 150 starts over the quarter.

So it's going to queue up as we move through the year.

But as we said earlier with regard to the restructuring that we've done in the business and our focus on moving towards incremental volume and absorptions in these communities, we think that you'll see the leverage.

When it comes through, it's probably you're not going to see it, you'll see sequential improvement as you've seen in prior years, but just give us a little bit of time and you'll reap the benefit from it.

Let me just add to that for a second and say that operating leverage is going to come in a couple of forms, not just the efficiencies that you've already seen but the efficiencies that we continue to be focused on.

We highlighted our digital platform in a small way in our opening remarks, but the migration from conventional marketing and advertising to a more digital platform is something that we still think is in its infancy in our business and offers an opportunity to further enhance the operating leverage that we can have by bringing some new systems and programs to our regular platforms.

So I think that we're quickly getting to some of the efficiencies that are embedded in what we've done, but I think over the next few years there's opportunity not just for us but for others in the industry to really enhance efficiencies by changing the way that we operate our business.

Okay, thanks.

Our next question is from Stephen Kim with Barclays.

Go ahead, your line is open.

Great, thanks a lot guys.

Another strong quarter, congratulations on that.

Wanted to just start off just with a comment which I think Mike earlier was trying to get at, which is that you just made an observation that sort of things in the forth quarter were a little bit softer in terms of the demand side, and the progression over the course of the first quarter was kind of normal sequentially.

And so if that was the way you described it, the implication might be that things are still a little bit not as good as maybe things had been in the past.

So I'd just throw that out as an observation there may be something's getting lost in translation, because what I'm hearing from your body language is that things are good, they're not great, they're certainly not bad, and you used the word optimistic, which can mean a lot of different things.

But my question actually relates to the first-time buyer.

You and many other builders have sort of talked about the fact that there's sort of some difficulties in that market, I know you've talked about it in the past, it's sort of not yet fully come into its own yet.

And I was curious as to when you think that market, that buyer type, might start coming back into the market in greater fullness, and what you're doing to prepare for it?

And I'm specifically interested in the timing of it and what you're doing in terms of like the land and things like that to go after that market.

Well on the land side, Stephen, this is Rick.

As we said in prior quarters when this question has been brought up, we've been focused on securing land positions that are right for this type of buyer.

Price point needs to be low, volumes need to be high because you're making a small amount per copy when you're closing the home.

So in order to be in this business you need to structure it as a volume-oriented business, because it's generally skinnier gross margins but rapid pace.

Since we benefit from the fact that we've secured the lion's share of our deliveries for 2014 and 2015, gives us an opportunity to tap out there and tie up some pieces of property, so when this buyer comes out we're positioned for it.

And that's exactly what we've done.

I would just add to what Rick said that we're also working with the buyers that are first-time buyers in sitting down with them and helping them from a credit counseling perspective, so that we're helping them to prepare to be able to qualify for a mortgage as that first-time market comes back.

So I just want to make sure that I'm understanding what I heard.

So it is your view, Rick, that your Company because of the fact that you've been sort of proactive in this and have identified this market as one that's going to come back, that you've already taken steps maybe perhaps more than your competition to position yourself to capture this market when the buyer demand increases there, or is this not a strategic focus for you versus your competitors?

I'm just trying to understand how important --

I'm not going to talk about what the competition is doing because I don't think that's particularly relevant to what our investor base is interested.

What I will tell you is that we have made a conscious effort to address this as a potential augmented business as the market recovers.

Right now the financing is a little bit tough.

There's down payment issues with this type of buyer, but given the demographics and what we know about the market, this market is going to come back.

I think that's why Stuart foreshadowed earlier in the call that our margins may be impacted a bit as we pursue a more volume-oriented approach as we capture and expand the business, so we are very focused on --

Got it.

It's something that will come but there's got to be a conscious effort to both tie up the land, build a program, and run a business that's a little bit different than the core business.

Okay got it, great.

That's actually very clear, thanks very much for that.

The second question I had related to your just another sort of buyer type, the foreign buyer.

And I know this isn't a huge deal for you guys, but in certain of your communities particularly on the West Coast and I imagine South Florida, it's kind of like parts have not noticed that there's an awful lot of concentration of a particular type of buyer that's not really making their homes here in the US traditionally, but they're buying property here in the US.

I was curious as to whether you could just sort of comment on how are you targeting that buyer?

Are you sort of creating communities based on what has sold and then this buyer is sort of coming for it, or are you actually specifically marketing to a foreign buyer?

And then maybe sort of as a follow on to that is, have you seen any change given the exchange rate, because the Chinese yen has weakened pretty considerably against the dollar recently.

Have you seen anything on the West Coast?

Maybe that's a question for Jon.

Yes, Jon why don't you go ahead and take all of that.

Sure.

We're definitely seeing more demand from the Chinese buyer and offshore buyer, but you have to really break it down into its buckets, Steve.

You have those that are US residents and then you have foreign nationals, and I'd say that the mix has changed over last year of what we're currently seeing, that you probably have a little bit more weighting towards the foreign national buyer that's coming in either all cash or 50% down.

Really haven't seen any change in the demand from that buyer because of currency activity, it stayed pretty healthy.

And you tend to see it in certain markets, so in San Francisco and Irvine, LA, are very strong markets for that buyer profile.

And we do selective marketing to that buyer profile for those markets, but we don't do it for the markets that aren't as popular for that profile.

Great, that's very helpful.

Thanks very much guys.

Our next question is from Robert Wetenhall with RBC Capital Markets.

Hi this is actually Desi filling in for Bob.

You talked about labor and material costs rising 9%, nearly 10% in the quarter.

You also mentioned that you've seen less pressure on the labor side, so do you expect to continue seeing maybe some relief on labor costs as volumes recover and contractors come back to the market, or is that a temporary development?

This is Jon.

I think that we're seeing as the recovery matures the labor force is getting more and more comfortable with hiring and acquiring equipment, so the labor force we feel is catching up, I wouldn't say it's caught up yet, but we're not seeing as much pressure as we saw before, and that's why we described it as an easing.

We'll still see overall costs go up, as Stuart mentioned certain material categories are going up.

Lumber has gone up slightly in the fourth quarter and first quarter, we expect lumber to go up a little bit more in the second quarter.

So I think you'll see a moderation of the year-over-year cost increase.

I would think it will probably be sequentially based on what's already in our system 3% to 4% higher in our Q2 deliveries over Q1, and that's slowly coming down sequentially and year over year.

Great, thanks.

And then getting back to the topic of pursuing land deals with maybe slightly lower gross margins but minimal SG&A outlays?

Are these projects you've already started to pursue or is that something you would start to do once the market reaches higher volumes?

This is Rick.

This is something that we've already started to pursue and are starting to get feathered in now.

Got it.

Thank you.

Our next question is from Jade Rahmani from KBW.

Go ahead, your line is open.

Hi, thanks for taking the question.

Can you provide any color on how land prices have moved over the last quarter and year to date?

I noticed you picked up your pace of acquisition and I wanted to see if you could comment on that.

So on a land acquisition side, keep in mind that a fair amount of what was purchased during the quarter was put under contract several quarters ago, maybe even years ago, so it's just the timing as it moves through the snake.

From a pricing standpoint, prices move, have moved up a bit, in some markets they've been flat.

It really depends on the flow of activity in the individual markets.

We're pretty comfortable with where the market is right now.

And as we've said in prior calls, we benefit from the fact that we're not primarily looking for immediate delivery-type effects.

Jon, any flavor from your side?

Yes, it's very market specific, so if you looked at a Phoenix, it definitely has flattened in that kind of market, but in coastal California it continues to be very heated and increases.

But as Rick said we're really well positioned with what we need for the next couple years, so we tend to be looking at the short-term quicker turns or more of an entitlement play where we can control land for the future and still have healthy margins.

Great, appreciate the color.

Just on the Financial Services side, I think you noted in the opening remarks about the retail strategy, you mentioned that could supplement volumes.

Can you discuss that in further detail on what that actually entails?

Sure, Jade.

Right now in total, we have over 90% of our originations are purchase originations, but we have a retail platform called Eagle Mortgage and it was heavily focused geographically on the West part of the country.

We are looking to open branches and expand that from the West Coast of the country across to the East Coast and expand that platform, still focusing primarily on purchase business but leveraging our back office and our systems to get some more operating leverage on that platform.

So this will be a slow, methodical growth program over the next several years.

Okay, thanks a lot.

Okay, why don't we take one last question.

Our last question is from David Goldberg with UBS.

Thanks for taking my call, everybody.

Good afternoon.

Hi, David.

My first question was on -- actually I wanted to ask a follow-up to a question Eli had asked earlier and Stuart mentioned seeing some loosening starting to come through, that's really the first we've been hearing from builders that some of the banks' efforts to loosen are starting to show up in actual builder results.

I was wondering if you could give us some more color on what is it, is it procedural loosening, is it credit loosening, is it loosening in terms of standards?

Can you just give us some increased color on what you meant by the comments and where you're seeing it?

Actually, I think we've been hearing it from most of the builders over the past quarters.

And the loosening has been a gradual, very gradual acceptance by the banks that the standards articulated by the GSEs and FHA, VA are not going to give rise to putbacks, and where they feel comfortable that they are not going to have putbacks, they've been loosening up some of the overlays that have been in place for some period of time.

Some of this is derived from just the practical application, the evaporation of the refi market.

As the refi business has dissipated, the banks have started to expand their desire to lend to more primary purchasers as they try to fill the void that's been left behind by the refi market, and we've seen that over the past year.

Bruce, maybe you'd like to weigh in on that.

Sure, and additionally, things like the mortgage insurance market coming back, we now have close to 40% of our conventional loans getting mortgage insurance, so they're putting down 20% to the tune of that 40%.

So all of these things are small steps but we're seeing it directionally heading the right direction.

I don't think you're going to necessarily see a big spike up, but all these things are healthy on the margins.

We've seen some of the overlays, as Stuart said, be eliminated.

But we're seeing some of the people coming out of the short sale and foreclosure time expiration period.

So the trend is positive with a lot of small steps.

I think we've also heard some of the banks articulate that they are going to rethink the subprime market and start looking at other avenues to opening up lending channels.

Right.

They're going to look to replace that revenue.

They lost the refinance volume like everybody else and they're looking to replace that, and they're eliminating the overlays that were put in place both with FICO scores coming down as well as some [market] conditions to be able to get the loan.

That color is really helpful, thank you.

And just a quick follow-up.

With the move in to the retail, some more retail operations on the mortgage refinance side, can you talk about the regulatory scrutiny you're facing?

We've heard from a lot of lenders that they've been facing increased regulatory scrutiny, including from the CFPB.

Can you talk about the costs in the business and if you think being in the retail side increasingly would open you up to more scrutiny as a mortgage originator?

Thanks so much.

Sure.

On the regulatory side, the increased costs, we had already put those in place over the last year or so with respect to more quality control, so that's been embedded in our program.

We haven't seen additional scrutiny; we follow the right procedures.

I think some of the scrutiny you might be referring to has also been on the servicing side with some companies that have bought large servicing portfolios, but our program is a methodical program following the same procedures we do on the purchase side.

So we're not expecting to be in a position that there's going to be scrutiny on the retail side.

We have a great group of associates with Eagle Mortgage, we're looking to leverage what's worked well for many years for us, so we're not expecting any issues there.

Thanks so much.

I appreciate the color.

Very good.

Well that wraps it up for today.

Very happy to report our results for the first quarter, and look forward to circling back and reporting on our progress throughout the year.

Thank you for joining us and we'll speak soon, bye-bye.

Thank you.

That does conclude today's conference.

Thank you for participating.

You may disconnect at this time.