Lennar Corporation (LEN) Q2 2011 Earnings Report, Transcript and Summary

Thank you for standing by and welcome to Lennar's Second Quarter Earnings Conference Call. [Operator Instructions] I will now turn the call over to Mr. David Collins, Director of Investor Relations for the reading of the forward-looking statement.

Today's conference call may include forward-looking statements that are subject to risks and uncertainties relating to Lennar's future business and financial performance. These forward-looking statements may include statements regarding Lennar's business, financial condition, results of operations, cash flows, strategies and prospects. Forward-looking statements represent only Lennar's estimates on the date of this conference call and are not intended to give any assurance as to actual future results. Because forward-looking statements relate to matters that have not yet occurred, these statements are inherently subject to risks and uncertainties. Many factors could cause Lennar's actual activities or results to differ materially from the activities and results anticipated in forward-looking statements. These factors include those described under the caption Risk Factors contained in Lennar's annual report on Form 10-K, most recently filed with the SEC. Please note that Lennar assumes no obligation to update any forward-looking statements.

I would like to introduce your speaker for today's call, Mr. Stuart Miller, President and CEO. Mr. Miller, you may begin.

Great. Thank you, and good morning, everyone. Thanks for joining us for our second quarter 2011 update. As always, I'm joined this morning by Bruce Gross, our Chief Financial Officer; Diane Bessette, our Vice President and Treasurer; and David Collins, who just read the statement, our Controller. Additionally, Rick Beckwitt, our President; Jon Jaffe, our Chief Operating Officer and Jeff Krasnoff, Chief Executive Officer of our Rialto segment are here to participate as well. I'm going to begin with some brief opening remarks about the current housing market in general. Jon and Rick will discuss our homebuilding operations. Jeff will update on Rialto's progress and Bruce will provide details on our numbers. Then of course, we'll open our phone lines to questions. As always, I'd like to request that in our Q&A period, everybody, please limit to just one question and one follow-up so that we can be as fair as possible to everyone. In the context of what continues to be a very challenging U.S. housing market, we are pleased to report our fifth consecutive quarter of profitability as we continue to position our company for future success. While it's now well-documented that the expected spring selling season of 2011 simply did not materialize, it is beginning to feel like the worst days of the housing market are getting behind us. Although sales, pace and price are still under pressure, traffic trends have continued to improve and real, traditional, primary purchasers, with the real desire to purchase, are showing up, recognizing the prices are low, recognizing that interest rates are low and that this is an excellent time to purchase a home. Make no mistake, stabilization and recovery will continue to be a slow and rocky process as traffic and desire have not yet translated into strong actual sales. These are, though, the first signs that repair of the market is upon us. Sales remain constrained by available financing and confidence. Today's ultraconservative home finance environment has been a limiting factor in the normalization of demand and confidence for both new and existing homes. But as lenders begin to lend again to appropriate underwriting standards, and they will, demand will be unlocked and in turn, increased sales and improved year-over-year comparisons together with positive press will create much-needed urgency and unlock consumer confidence in the housing sector. At Lennar, we've just completed our second quarter operations reviews with all of our Division Presidents. We've gone through the operations and business plans of each of our divisions and reviewed the performance and position of each division and their respective market. I find myself somewhat optimistic about the future of the housing market in general and for our business, in particular. In almost all of our divisions, we are finding that there are pockets of activity that are actually strong and across our markets, primary buyers are venturing out from a long, cold winter to consider purchasing. While the overall landscape remained somewhat troubling from a short-term macroeconomic perspective, at Lennar, we've remained profitable in the short-term. We have sharpened our focus on our core Homebuilding business, given the current economic conditions while we position for an ultimate recovery. Driving profitability, we have gotten a lot of components of our business working. Our product research and reworked product offerings are working to compete favorably with the existing home market and foreclosures. Our dramatically reduced cycle time is working to enable less reliance on standing inventories for sale. Our intense focus on driving construction cost lower is working to enable value-oriented sales prices. Our low inventory approach to sales and start is working to help maintain our industry-leading margins. Our carefully managed overhead levels are working to drive comfortable net margin even at reduced volumes. Our Everything's Included marketing platform is working to highlight our value-oriented offerings to our customers. Our strategic land purchases leveraging our Rialto relationships are working to position us with low-cost land to drive higher margins. And most importantly, our extremely strong management team that has driven this company through the best and worst of times, is working day and night to stay a step ahead of market movements. We confirmed in our operations reviews that the controls and strategies that we've put in place over the past difficult years are working very well to enable us to remain profitable even at reduced volumes. Jon and Rick will review some of these elements of our Homebuilding operations that are succeeding. Additionally, our Rialto program continues to complement our Homebuilding activity as it also adds to our overall profitability. Rialto has continued to grow and Jeff will update you on this progress in just a minute. All in all, we are very comfortable with the position of our company. We know that market conditions remain difficult. We believe that our willingness to confront the reality of market conditions, honestly and early, has enabled our company to make the important and necessary adjustments to quickly pivot to profitability and to properly position for the future. Let me turn over now to Jon.

Thank you, Stuart, and good morning. We're very proud of the pre-impairment 19.1% gross margin and 5% operating margin we delivered in our second quarter. I will speak to our company strategy on maximizing revenues and our intense focus on managing direct costs and overhead. On the revenue side, we are focused market-by-market on driving sales by zeroing in on today's home-buying consumer wants and needs. We deliver value by targeting the right product and features. Each of our divisions has redesigned floor plans, square footages and features to address today's customer profile. Additionally as Stuart has noted today and in past calls, we have reignited Lennar's Everything's Included platform to highlight the energy-efficient, technological and quality features that clearly differentiate our new homes as compared to the resale homes on the market. In the area of energy efficiency, which is a real differentiator when compared to used and foreclosed homes, we're designing our homes to save customers around $1,000 per year on their electric bill compared to the typical existing home. In some of our markets, we have homeowners who experience monthly electric bills that average below $10. We are also including home automation technology that allows our homeowners to control door locks, lighting, thermostats, cameras and more through their Smart phone, iPad or computer. These today's technology features allow homeowners to enjoy their home in a way that previously, either wasn't available or it's too expensive for them. We believe this strategy is allowing us to maximize our sales and sales price by giving customers a reason to buy in the current difficult market environment. On the cost side of the margin equation and at the same time as we are executing our Everything's Included strategy to include more features that appeal to today's customer, we continue to drive down the direct cost of construction. Our current average direct cost at homes are approximately $40 per square foot. This is down over 30% from the 2006 peak and is a year-over-year reduction of over 5%. We achieved this result through the hard work of extremely well-coordinated national and local purchasing teams that continually find the answers on how to deliver more value for less. We've also stayed focused on bringing down our cycle time which is now down 27% from the peak. This is accomplished by working hand-in-hand with our trade partners and designing and building more efficient value-engineered homes. This effort has allowed us to control our fuel cost and effectively manage our inventory. We have also maintained our intense management of SG&A. As market headwinds result in downward pressure on home prices, we know that we have to [indiscernible] every day to reduce our cost structure. Despite the cost associated with new community growth and today's overall lower absorption levels, our year-over-year SG&A spent for second quarter was flat at $97 million. At 14.9%, this represents a year-over-year increase of 100 basis points due to the decline in revenues of 6%. To put our overhead focus into perspective, at the peak of the market in 2006, SG&A was $484 -- $484 million compared to our Q2 2011 run rate of $97 million. As Stuart mentioned, we have just completed our operations reviews with each of our Homebuilding divisions. I can tell you that despite the reality of a disappointing spring sales season, we have a team that is energized to execute on the strategy of maximizing sales revenue and the goal of maintaining industry-leading operating margins through the active management of reducing cost of sales. Thank you. I'd now like to turn it over to Rick.

Thanks, Jon. During the quarter, we continued to focus on acquiring or optioning new home sites that would have a positive impact on our bottom line. We signed 25 new deals to purchase approximately 2,900 homesites. About half of these deals were option contracts where we put up a small deposit and have a right to take down the land over time. The remaining deals were cash purchases or distressed loan purchases where we subsequently foreclose on the land. Our land spend during the quarter was approximately $109 million, down about $50 million from the first quarter. At the end of the quarter, we owned or controlled approximately 108,000 homesites. All of these new deals in the quarter were underwritten with extremely conservative underwriting assumptions. They assumed no price increases and in some cases, price declines, slower decline in sales basis and where price to yield gross margins and IRRs exceeding 20%. Jon and I review every transaction regardless of size and absolutely no money leaves this company without a thumbs-up from me, Jon or Stuart. Today, we've been very pleased with the performance of our new communities, even as the market has trended downward. During the second quarter, approximately 30% of our deliveries came from communities purchased or put other contract in the last 2 years. Our gross margin on the closings in these communities was approximately 21% or about 200 basis points higher than the gross margin for the entire company in the second quarter. From a geographic standpoint, approximately 32% of the new deals are located in Florida; 20% in Maryland, Virginia and the Carolinas; 18% in California; 13% in Texas, but the remaining 17% spread throughout our other markets. Our focus within these markets has been on desirable communities located in submarkets where people really want to live. Whether the hook at schools, spectacular amenities or commute time, each one of these new deals has been selected with a very specific target buyer in mind. In short, we've stayed away from fringe locations or opportunities where price was the only driver. Given our laser-type focus on land, our product strategy has been a key driver to our success in these communities. We have ensured that we have a cost-effective home design in hand before we buy land, which has allowed us to streamline the time period between when we buy and when we're open for sales. It's a true cash-on-cash focus. We don't want to waste on chasing deals that fall outside of our floor plan universe. This allows us to use realtime and proven cost information when we underwrite new deals . As I've mentioned in the past, we've been direct sourcing the lion's share of our deals and have tried to stay away from the broker-to-bid transactions. This has allowed us to get in early, buy and try out multiple deals at a time and negotiate much more favorable pricing in turns. I have no doubt that we have the most talented and hard-working land team in the business. This team working together with our Rialto associates has been particularly effective. We've worked closely with the banks, partnered with the government, bought foreclosed properties, tax certificates and community development bonds . We think that some of the best opportunities are the more complicated deals. and I'd like to thank our team for their hard work and dedication. Now I'd like to turn it over to Jeff Krasnoff, the CEO of our Rialto operations.

Thanks, Rick, and good morning, everyone. As he does each quarter, Bruce will shortly be reviewing the details behind our $9.8 million of operating earnings, along with the results for the year and the rest of the company. From an operating standpoint, Rialto's real estate portfolio, securities and investment management businesses continued to be very busy. During the quarter, our Rialto real estate fund, in which the company had both a major investor and the manager, closed on 2 new distressed real estate loan portfolio transactions representing $140 million of unpaid principal balance. But we've also tied up another 8 new loan portfolios, which subject to completion of closing conditions, should add loans with an additional $350 million of unpaid principal balance. We also closed on 2 new-issue commercial mortgage-backed securities transactions and have 2 in the pipeline, representing a total of $320 million of securities, backed by over $5.5 billion of newly underwritten cash flow in commercial real estate loans. All told with the transactions we've already completed and those in our pipeline, we estimate in the next 30 to 60 days the fund will have invested approximately $340 million in equity since its inception late last year, to buy approximately $940 million in assets at a little over a 60% discount to par. As a reminder, in addition to the approximately $450 million of equity it has invested directly before the inception of the fund, the company has committed $75 million to be invested through the fund and has the ability to co-invest in larger transactions. The additional equity commitments that we expect to add in closings in the near future will be adjusting the company's ownership percentage in the approximately $370 million of commitments closed to date. As we've mentioned in the past, we've received fees for pursuing and money managing fund investments and we also earned incentive fees based on the funds performance. Since we last reported to you, along with other fixed income assets classes, RMBS and CMBS have experienced a widening in spreads, thereby increasing yields and reducing pricing. As Bruce will walk through, this had an impact on our mark-to-market this quarter for our investment in our PPIP fund with AllianceBernstein. But it also increased the attractiveness of certain targeted securities. Therefore, for the first time in several quarters, our PPIP fund has called additional capital in order to be prepared for attractive acquisition opportunities. On the operations side, we continue to build an outstanding team of professionals, which has now grown to over 150 associates across the country. Our team is currently evaluating an unusually large pipeline of opportunities primarily from financial institutions, divesting troubled loans that are burdening the balance sheets. Our already in-place managers are today, working out loans, dealing with similar underlying collateral on the same markets and in a number of cases, the same borrowers. If we're able to purchase assets at our pricing, we're positioned to quickly and efficiently bring those assets right into our already in-place workout machine. And because of a higher percentage of loans made to developers, being able to efficiently incorporate the homebuilding team's unique view and expertise gives us another distinct advantage in our evaluation and maximization of value for these assets. As part of this active collaboration, the Homebuilding divisions have also been able to capture distressed opportunities from the same institutions we've been working with on the portfolios, the mechanism to generate new communities at extremely attractive pricing. Since we started this program, this has led directly to the company's investment of almost $100 million to acquire thousands of extremely well-located homesites for use in the company's Homebuilding operations. We remain very excited about our growing franchise, our current position in the marketplace and the synergies with the rest of the Lennar team. And we look forward to reporting to you on our progress in future quarters.

Thanks, Jeff. This is Bruce Gross. Revenues from home sales decreased 6% to $650 million during the quarter, and that was due to a 9% decrease in home deliveries, excluding joint ventures which is partially offset by a 2% increase in average sales price to $245,000. The average sales price by region is as follows: the East region, $233,000, up 5%; the Central region, $209,000, up 6%; Houston, $231,000, up 7%; the West region, $308,000 down 3%; and the other category, $269,000, up 6%. The changes in average sales price were primarily due to product mix during the quarter. During this quarter, we had only $3 million of Homebuilding community impairments, which is the lowest quarterly Homebuilding impairment amount since we've started the impairment cycle 5 years ago. Our gross margin on home sales pre-impairment was 19.9% as Jon mentioned, and that compares with the same pre-impairment amounts of 21.4% in the prior year and 21.1% in the first quarter. Gross margins were strongest in the East region this quarter. The gross margins from our new communities continue to outperform, but were partially offset by a modest increase in sales incentives on homes closed. Sales incentives increased by $2,800 from the prior year to $33,900, an increase of approximately $800 from the first quarter. As a result of the strong operating leverage noted in our sequential 150 basis point improvement in SG&A to 14.9%, our Homebuilding operating margin, also pre-impairment, also improved sequentially from the first quarter as it was up 30 basis points to 5%. Other income net totaled $9.5 million in the second quarter, of which $5.1 million was due to the hard work of our associates and resulting in a favorable resolution of a joint venture. And the remainder was primarily management fees and interest income which you typically see each quarter. Our Financial Services business segment generated operating earnings of $2.3 million for the quarter versus $13.7 million in the prior year. The reduction was due to decreased volume in both our mortgage and title operations and the prior year results included a $5.1 million gain relating to the sale of a cable system. Mortgage pretax income during the quarter, was $5.3 million and that compares to $9.3 million in the prior year. And our title company had a $2.2 million loss compared to a $400,000 loss in the prior year. Our Rialto business segment generated operating earnings of $9.8 million and this number is net of $12.9 million of net earnings attributable to noncontrolling interest. The composition of Rialto's $9.8 million of operating earnings by type of investment is as follows: $9.5 million is a contribution from our 40% share of the FDIC portfolios; $11.9 million from non-FDIC portfolios; $2.4 million loss is from PPIP, that's approximately $8.3 million of G&A and other expenses which are net of management fee income. The $9.5 million of contribution from the FDIC portfolios this quarter is primarily from accretable interest income, collections from guarantors and gains upon foreclosure of REO. The $11.0 million of contributions from the non-FDIC portfolios is comprised of accretable interest income, sale of REO, gains upon foreclosure of REO and a $4.7 million gain on the sale of the CMBS bond. The $2.4 million loss during the quarter from our investment in PPIP, as Jeff discussed, is reported as the equity in earnings from unconsolidated entities. And this loss is comprised of a $5.5 million unrealized loss due to the mark-to-market adjustment from the widening of spreads discussed by Jeff. This was partially offset by $2.6 million of interest income in the PPIP. At quarter end, Rialto continued to generate cash. They had $160 million in the diffusive cash account to retire debt and there was an additional $70 million of cash on Rialto's balance sheet. Lennar's balance sheet continued to be strong and liquid at the end of the second quarter and our leverage remained low. Our Homebuilding debt to total capital net of $945 million of cash was 44.9% at the end of the quarter. And inventory, excluding consolidated inventory not owned, stayed flat at $3.9 billion. Our backlog conversion ratio during the quarter increased to 138% as we remained focused on carefully managing our inventory levels. This conversion ratio was higher than normal as a result of our successful focus on reducing our completed unsold home inventory count from a 1,059 at the end of the first quarter to 696 at the end of the second quarter. We had 449 active communities at the end of the quarter. And as a result of another profitable quarter, we were able to continue to reduce our deferred tax asset reserve, which now stands at $599 million. Shareholders' equity increased to $2.65 billion with a book value per share of $14.18. In conclusion, we are pleased with our continuation at reporting quarterly profits. And given the current market conditions, we remain confident that 2011 will be another profitable year for the company. And with that, we'll turn it over for questions.

At this time, we will now begin our formal question and answer session. [Operator Instructions] The first question is coming from Dan Oppenheim of Crédit Suisse. Daniel Oppenheim - Crédit Suisse AG: I was wondering if you can start off talking about the strategy in Homebuilding business? Touch about your focus on minimizing the level of specs there. But if you look at the backlog conversion, you'd see in that you've got a lot of homes there converting to sales pretty quickly. How do you strive on terms of what you're doing to specs and how you're managing that process?

So, Dan, with respect to managing the specs, we're matching our sales in our construction pace. This particular quarter, we had about an extra 360 or so homes that we're able to close because they were completed and our strategy is to focus on those homes and keep that count as low as possible. But from the standpoint of what we're starting in construction, and Jon maybe you want to touch on this, we're matching out with our sales base.

Sure. We monitor the absorption community-by-community and accordingly, set a start pace for that specific community. Those things end up -- we experienced in today's market is that our biggest competitor is the existing home. And the brokers, particularly, and the customers are comparing a finished home to our homes. And the ability to have some homes that are near completion really allows us to compete more effectively with the existing home. And of course, our focus on cycle time also allows us to effectively control the fact we started some homes that aren't sold yet. Daniel Oppenheim - Crédit Suisse AG: Great. And the second question. Wondering about the pipeline or transaction of Rialto business, that's unusually large. Any sense in terms of what you've been seeing in the past, since you've been looking transactions in the pipeline? What end -- percent end the up closing? How realistic it looks to be in terms of, say, large volume here and the next couple of months?

It's Stuart, maybe Jeff will follow up. But in terms of pipeline, our pipeline percentage that end up closing, it's been about 100%. We're pretty much looking at a pipeline that we don't tie up unless we have done due diligence ahead of time. And we have a pretty strong degree of certainty that we're going to close the deals that we've tied up. In terms of the pipeline of activity that's out there, there's no question that the market is really starting to put out a lot of product that has been pent-up and saved up inside of the lending institutions for some time. So the activity is clearly getting pretty heavy right now. We're underwriting a pipeline of new potential deals that is much larger than we've seen over the past quarters. And we expect this activity to continue for sometime now. Jeff?

Yes. No, I'd say a large percentage then, of what we're looking at are negotiated transactions. And usually when we start going down a path, we typically end up with the deal at the end of the day. It was some give-and-take with the financial institutions. In some cases, we do if we think that it's going to be a very thinly bid transaction. We may bid some transactions and there might be a few of those that don't get done because they don't get done at our price. But for the most part, the supply right now is overwhelming a number of qualified buyers really in the marketplace.

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

The next question is coming from Ivy Zelman of Zelman & Associates.

We got a lot of questions from investors on is it better to be land light or have land given that the outlook seems pretty ominous right now by many? And also, should you be a move up or entry level, and seems to be a push to move up. So realizing that's 2 questions in one. If you can to help us frame your views of that. And lastly, I'll get my second question without getting back in queue. Pricing. Your view on what pricing does when you're underwriting ground, do you think it's going to continue to go down in the next 12 months?

Well, on the land light versus land heavy side, Ivy, this is Rick. We're being very opportunistic with regard to what we're putting under contract, how we're underwriting it and when we're investing the dollars. All we can really point to is what the numbers have been with regard to the investments. Pretty much across-the-board, we've invested in new opportunities that far exceed the gross margins in some of the legacy assets. So from a cash investment and a return standpoint, those things have been really money good. As we look at the cycle and we look at the opportunities out there, we have changed some focus at various times in different markets from some of the finished product that's available out there because some of that has been bid up to things that may be more busted deals, to give us an opportunity for really outsized returns as we fix the issues that are out there. Pricing, we've seen pricing bounce around. As I said in some of the prepared remarks, when we underwrite these deals we underwrite them with multiple variables in mind. We look at them on a base case as if everything is flat. We look at them with declining sales prices, declining absorption rates, cost inflation. Really, we split it and we analyze it in multiple ways. At the end of the day, it needs to pass muster at the worst-case scenario based on absorptions, based on price decline, based on cost inflation and all of those type of variables. And once it does that, we make the investment decision.

Let me just add to that. You asked about pricing assumptions relative to our underwriting. We're buying a variety of types of properties these days. Some of them are shorter term under a land-light kind of concept. In those instances, we are not making pricing assumptions to the upside or downside. We're looking at normal market conditions. We're coming out [Audio Gap] staying very close to the market. We are probably more predisposed more towards move up right now. But in longer-term land positions, we're leaving ourselves a lot of flexibility. I don't think that we can look at current market conditions as a proxy as for where the market is going to go over the next couple of years.

The next question is coming from Michael Rehaut, JPMorgan Chase. Michael Rehaut - JP Morgan Chase & Co: First question just on May. In the press release, you discussed that being up 30% year-over-year in terms of order, so I was wondering if you could give us a sense of sales pace and also how pricing and incentive trends have been relative to -- sequentially relative to April? Just as -- just, month-to-month how you've seen things trend?

Sure, Mike, this is Bruce. The sequential trend from April was pretty flat as you look at pricing and as you look at the sales incentive trend. So we've hit somewhat of a stable point. It was sequentially improving throughout the year and from April to May, it's pretty flat. Michael Rehaut - JP Morgan Chase & Co: And that flatness would then be also with regards to sales pace?

Yes, sales pace is about flat as well. Michael Rehaut - JP Morgan Chase & Co: Okay. Second question on the gross margin. Still staying in that essentially 20% to 21% range, and I think basically, you said last quarter that the backlog gross margins were up approximately 20% -- at the 20% level. So I guess the question is going forward to the next couple of quarters, do you expect to remain essentially in that 20% to 21%? Or given the, perhaps say, increase from closings in new communities over to the extent that you can perhaps achieve some further benefits from lowered cost per square foot, are there any things that might drive your expectations towards higher -- the higher end of that 20% to 21%? Or just how should we think about that going forward?

Hey, Mike, this is Rick. As I said last quarter, I think the zip codes that you really should focus on is really 19% to 21%. Because Jon and I, every month, every week, are making pricing decisions with regard to market movements that are realtime. Clearly, the new communities have the ability to push the overall blended gross margin up to the higher end of that range, but we have to react on a daily basis to the local market movements, the traffic conditions and it's going to sort of move in that category. And if you look at the guidance that we gave you last time, we sort of came in right the middle of that curve.

Mike, to your point about direct cost reduction. We continue to look forward and expect we're going to have to continue to reduce cost structure in the current market environment knowing that price pressure can continue to move downward and so we're forward-thinking and forward-looking in terms of what's the next solution to deliver value and reduce cost.

The next question is coming from David Goldberg, UBS.

My first question actually is something of a follow-up to Mike's question and I appreciate the details on the cycle times and the direct cost per square foot. But I'm trying to get an idea of how you guys benchmark your efficiency and your purchasing relative to kind of your internal goals and your targets and also relative to what your competitors are doing? I'm just trying to get an idea coming to do what's left for you there in your minds? And how do you kind of -- as you think about it over time? How do you determine how well you're doing? It seems pretty impressive. So?

Well, from a benchmark standpoint, I think that we feel that we're doing the best job in the industry. And we've got great people in the field. We've got excellent purchasing folks. We are construction superintendents. Our builders out there are focused on keeping that house moving from the date we pour the slab until we give the keys to the buyer. So cycle time is incredibly important in this company. And how much further can we compress that time period? That's going to be a lot driven by the increased efficiency in the designs and some of the things that we're doing along those side. From a cost perspective, the purchasing perspective, we're continuing to battle with some of the influence of the manufacturers are trying to push costs up. But we've been very effective in keeping things down. And what's going to be interesting is what happens when the cycle turns and how much of that cost increase that we can battle against. But I think that when that happens, we should be able to more of -- than offset that with price increases of a product.

At the end of the day, I think that we've set no limits on ourselves as to how far we can drive cycle time down and cost down. We think that there is room for marginal improvement. As volumes go down, everybody through the supply chain is under pressure. And we keep that pressure applied. We recognize that there's going to be some give-back as the market comes back. But while the market has been trending lower, we are looking for participation from the cost side of the equation to keep us in a steady profitable zone. So we think that there will be more movement. We know that there's pressure to the upside. Everybody is trying to make a dollar here. But while the market is moving down, we think that we can make some more improvement.

Got it. And then just my follow-up question here. Interesting to hear about more type with the reinvigoration of Everything's Included. I'm wondering if you can talk about -- you also talk about, in your individual communities and individual markets, building the product that meets the customer demand. And I'm just trying to get a sense of how your Everything's Included product, what is included, differs market-to-market, buyer segment to buyer segment? Do you find that people generally want the same things in those 3 markets and so you get to know purchasing power on more of a national basis in one of those products or is it kind of different market-to-market? Can you give us some color on that?

Let's start by thinking about it this way and Jon will add to this. Think of Everything's Included as kind of a 3-tiered program in today's world. It's about an energy program. It's about technologies, modern technologies. And it's about included features. We are fully focused on energy savings as a differentiation mechanism from used and foreclosure homes. That's our biggest competitor. And it's the biggest area of vulnerability for that competitor. New homes offer a better energy program and we're doing everything we can to enhance that and that's pretty much across-the-board. The energy component of Everything's Included is something that -- it might vary somewhat market-to-market based on whether we can do solar in one market or wind loads in Florida and things like that. But we're focused on the energy component. Technology comes down to you wouldn't buy a car with roll-down windows. We want to enhance the technology around our homes to where we're competing with that existing home market, aggressively, by enhancing the technology, today's technology, around homeownership. That means keyless entry doors and switch-less lightning and stuff like that. We think that we can enhance that program and that we're doing market-to-market. The features component of our Everything's Included program is a highly researched, highly market-focused component. And that's the third leg of Everything's Included. And there, we do a lot of product research. We are basically looking to deliver the home that our customer would select if they were going through the selection process. And that means that our people in the field are doing a lot of product research to come up with the end solution for the homebuyer that they would choose if they were choosing it on their own. So we're doing the work for them and that's very locally market-driven.

That was going to be my point. It really starts with market research and it does lead us to different answers in different markets. They're just different taste relative to style and likes from someone living in Florida to somebody living in Minneapolis to someone in Phoenix. They tend to fall into common categories but the application and execution of that will definitely vary market-by-market.

Yes. And it all comes down to market-by-market, what do they want in that home, what would they select on their own? And balancing that with what they can afford and putting that package together in the most dynamic way possible.

The next question is coming from Jade Rahmani, KBW. Jade Rahmani - Keefe, Bruyette, & Woods, Inc.: Just on Rialto. I wanted to find out has the timeline for deals coming the market, due diligence, spending or anything related to the process, materially changed? The things that wouldn't change is you're looking at more and more negotiated transactions. And then the follow-up would be, I take it from your comments that based on what's expected to close in the next 60 days that the opportunity fund is fully invested. Can you give the schedule of future commitments on this fund? And Lennar's incremental investment? And if you raise a follow-on fund of this size, what do you think the timeline for the capital deployment would be on that?

Well, I'd say first off, I think you hit it right. I mean, we're certainly doing a number of negotiated transactions and a number of them are would sort of repeat, are repeat sort of sellers for us. And that market, it is growing. We're trying to add new people to that program as time expands. And as it relates to the equity, I'd say that -- I mean, we're still full in the market so I can't necessarily give you a lot of information on that other than the fact that we do expect to have continuing closings on commitments with for this fund before closing it up and starting to raise the next line.

Well, just add to that. I think that the field of opportunity has expanded. There is a great desire on behalf of the sellers to end up with a transaction that actually closes. There's a lot of noise out there, a lot of participants in the market that are not experienced in this arena and so the certainty of close becomes a little bit more questionable with them. There's a premium placed on groups like ours that have the ability to come in and, in a credible way, diligence, the offering and come up with a deal that will actually close. We bring that to the table. That's a differentiation from how the deals had been over the past quarters. I think we have an advantage that gets us in the door. And it gives us an advantage in terms of putting together a program that we can purchase at attractive pricing. In terms of our ability to invest, we have invested the fund money very efficiently and effectively at what we think are very attractive returns. We will continue to invest fund money as we go forward. And we think that we are not going to be capital-constraint Jade Rahmani - Keefe, Bruyette, & Woods, Inc.: Just a clarification, is there a maximum size the opportunity fund that you could disclose? And also how you think about Lennar's capital allocation to Rialto? Is there some limit to how much you would invest? Thanks a lot.

I think we've stated that in terms of this fund that Lennar's commitment is $75 million. But it also has the opportunity if there are larger transactions as to co-invest side-by-side with the fund. So we do have that. I don't believe we've actually disclosed the total amount, the maximum amount of the fund. But on the face of it the first fund is $750 million.

And let me just add. In terms of Lennar's investment, we are investing capital through our Rialto fund and through our Rialto program. The returns are really the primary driver behind how many dollars we will invest on the Rialto side versus land opportunities for the Homebuilding side. Where we find outsized returns, that's where the dollars will flow. And as a company, we remain opportunistic, opportunistically focused on how our capital gets invested. Next question?

That is coming from Megan McGrath, MKM Partners.

I wanted to follow up a little bit on the pricing environment and the incentives. Wondering if you could give any more color on the increased incentives? Did they come in a particular time in the quarter for particular product? Was it to get rid of that spec mostly? Or do you think they'll kind of stay at this elevated level at least? Did you see that in June?

On a percentage basis, it stayed relatively flat throughout the quarter. And as we've said in prior calls, we use our inventory as a tool and we price to close, to hit the pace of what the operation should achieve. We haven't seen a dramatic change, one way or the other, in post the quarter.

This is Jon. Now that -- if you look back the last 3 quarters, it's really been relatively flat. Like everything else, it's very local and it does vary by market-by-market and what's happening within those regions and submarkets.

Great, thanks. And then just a little bit of switching topic but wanted to follow up with Jeff on your comments around that unusually large pipeline. Any thought as to what's driving that on the part of the banks? Do you think it's coming under pressure? Do you think their outlook for real estate has one down? What do you think is increasing the pipeline so much?

Well, I think it's all of the above. I think they're getting increased pressure from regulators. I think that they're also -- there is also a lot -- there is also pretty significant fatigue that's set in, in terms of some of the portfolios that they've been trying to work for some period of time. And I think that right now, they're looking at the marketplace and they're looking at the opportunity for buyers like us to be able to dispose of these assets or get them off their books. And I think that all of those dynamics is sort of work together. And on the other side of it, in terms of the -- in terms of the number of investors, there are still relatively few that have the kind of infrastructure that's required to be able to look at large portfolios that cover diverse geographic areas and property types and so on. And as a result, sort of the supply right now, the way we see it, is sort of overwhelmed the demand.

The next question is coming from Kenneth Zener of KeyBanc.

Hi, this is Rodny Nacier, on for Ken. I wanted to clarify on the units on the construction. How many units do you have finished and how many are under construction? And how does that compare to last quarter?

We indicated that we have 696 that are completed unsold, which compares to 1,059 last quarter. And what's under construction both sold and unsold is approximately 3,700 versus just under 3,000 last quarter.

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

We don't project that, Rodny, because it's too hard to predict how many communities would be falling off as well. The number will increase because we're finding good opportunities and investing capital. But we don't actually put a prediction out because it's too hard to project that.

The next question is coming from Nishu Sood, Deutsche Bank.

This is actually Rob Hansen on for Nishu. You briefly touched about -- touched on lending standards. And I just wanted to get your thoughts on how tight they are. And we've recently heard from one builder that said that for the first time in 3 years, there's a slight easing in lending standards. So I'm just wondering if you get your thoughts on that.

Well, okay. That kind of takes me a little bit by surprise that you're getting that feedback. I think that the lending standards are pretty tight right now. And even stated standards where you might find that a FICO score of 580 is prescribed, the actual underwriting is probably solving to something in the 620 or 640 range, with conservatism built-in, given the fact that some of the rules are uncertain and some of the hold back requirements and requirements to almost guarantee loans that are being put in programs was out there. It's our experience that there is a lot of pressure to maintain kind of an ultraconservative spend on kind of government-sponsored loans. We think that, that kind of a crimp in the demand that's naturally out there right now. And it seems that over time, there will be a form of loosening of that tightened credit standard. When that will actually take place or how it will be effectuated is something that I don't think anybody can predict right now. But I do think that financing is a big limiting factor for natural normalization of demand right now and it's an opportunity for the housing market as we look ahead. An opportunity for the market to correct.

This is Jon. As you think about it, in every market of record affordability which typically brings out first-time buyers who weren't able to afford to purchase a home in better times. And what we're seeing today for that first-time buyer, the administrative hurdles of credit today make it very difficult. And so that demand that is out there, as Stuart noted, it's very hard to convert into an national homeowner.

The next question is coming from Adam Rudiger, Wells Fargo Securities.

Most of my questions have been answered but this one, its's the first of those housekeeping. If you could tell me on owned versus option lots, and then had a question on SG&A. I would've expected probably, I think a little bit less, a sequential increase in SG&A given, with, I guess is, much more operating leverage there, more of a kind of a fixed cost we're currently running at. So I was wondering if you could comment on that and maybe, if possible, break out within the SG&A. What part of those expenses might have been attributed to new community openings?

Let me give you the piece that is, I'm going to say, something controlled. We had 108,000 total owned and controlled of which 91,000 was the owned piece during the quarter. And as you're looking at SG&A sequentially, keep in mind that we've been opening at least, I think, it's around 50 communities or so per quarter. And as part of that, we do expense some of the cost of the models and grand openings before you have any deliveries. So there is a piece of that, that goes, but I don't have the exact percentage per se but that's [Audio Gap]

We could assume that there could still be some additional cost running through there? And any idea that I think some of the builders have talked about being a somewhat of the fixed cost level right now? And you could -- you can increase volume without any corresponding increase in expenses, is that potentially little bit inaccurate given that you have all the new community openings still?

Well, here is the way we look at SG&A. We think there is significant operating leverage in SG&A. And the formula that we've put out there is as we open a new community in an existing division, the incremental SG&A percentage attributable to new deliveries in that community is about 7%. So we think as we go forward and we increase deliveries from this recent community openings, there is operating leverage that will reduce the SG&A percentage going forward. And I think we'll take one more question.

The last question is coming from Stephen East, Ticonderoga.

This is Paul Shobalfian [ph] on for Stephen. Your orders have been trending down for several quarters now in Houston and I was wondering if you might be able to give a little bit of color on the reason behind that?

Well, this is Rick. Houston continues to be a very tough market. We've had some things go on in the market that are somewhat aberrational starting with the oil spill. And stemming from that, the curtailment of a lot of oil and gas spend given the activity that went on there. In addition, there was the Continental-United merger, which was had a big impact on the employment base there. And we're starting to see stabilization of what we've got going on in Houston. From an income statement, the division still operates on a profit for us. And we're looking at over the next several quarters to see that turnaround. We think our communities are very well located there. There's no doubt in our mind that we're really outperforming the competition in that market. It's just very noticeable when you had a very large division that we've broken out on individual line item go through a very tough market correction.

Okay. And then your community count growth was a little bit lower than we were expecting this quarter. And I guess that you've been opening roughly 50 communities a quarter. Were there more closings, close-outs this quarter?

Yes, there were several communities that came to their end, either because we built through them or decided to walk away from them. Benefiting from the options structure that we have with regards to those deals. You will see through the balance of the year as things come on book and things move off. We are very encouraged when we get to move through some of our asset base. And so that -- we view that as a pretty good thing.

So the net increase is probably in line with what we should expect this quarter as far as community growth?

Well, as Bruce said, what we're trying not to give you projections on community count. The timing of when they open, there's lots of variables. But I think that the trajectory is towards the up side. And that's what we've said for the last several quarters

Great. Well, thank you everybody for joining us. And we look forward to keeping you posted on our progress and reporting again, next quarter. Thank you.

This will conclude today's conference. All parties may disconnect at this time.