Lennar Corporation (LEN) Q3 2013 Earnings Report, Transcript and Summary

Thank you for standing by, and welcome to Lennar's third quarter earnings conference call. [Operator Instructions] Today's conference call is being recorded. If you have any objections, you may disconnect at this time. I will now turn the call over to Mr. David Collins 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.

I would like to introduce your host, Mr. Stuart Miller, CEO. Sir, you may begin.

Great. Thank you, and good morning, everyone. Thanks for joining us for our third quarter 2013 update. We're very pleased to share our results with you this morning. This morning, I'm joined by Bruce Gross, our Chief Financial Officer; David Collins, who you've just heard from, who is our Controller; and Diane Bessette, our Vice President and Treasurer. Additionally, Rick Beckwitt, our President; and Jeff Krasnoff, Chief Executive Officer of Rialto, are here with us for our Q&A session. And Jon Jaffe, our Chief Operating Officer, is available for Q&A from California by phone. I'd like to begin this morning with some brief overview comments on the overall state of the housing recovery in the context of today's ever-changing market conditions, and then briefly overview our operations. Bruce then is going to, as usual, provide greater detail on our overall numbers, as well as some further comments on our Financial Services segment. And then, as always, we'll open up for Q&A. As in the past, we'd like to request that during Q&A, each person limits themselves to one question and just one related follow-up. So let me begin. In preparation for today's call, I reviewed my comments from last quarter's conference call to consider those comments and see how my thoughts might have changed. When we reported last quarter, our results were very solid, though the interest rate environment had begun to change, and talk of the pending taper of federal stimulus had just recently begun. We believed then, as we do now, that, generally speaking, the housing market remains in a solid recovery mode and is likely to continue to improve over an extended period of time. While the rate of that improvement is likely to moderate as the market has now snapped back from the abnormally severe downturn that we experienced, we nevertheless believe it will continue to improve. Clearly, interest rates have moved higher and mortgage rates have moved from their unprecedented low point towards more normalized levels. Accordingly, over the past couple of months, we've experienced a slowdown in our sales pace and traffic in our communities as the consumer has adjusted to the change in the interest rate environment. But it is our belief that this change is mild and temporary given the extremely low levels of housing inventory in the market. In our view, the primary driver of our business strategy is that the housing recovery is still very much intact and that the fundamentals of that recovery remain solid. The overriding driver of recovery in the housing market remains the production deficit of both single family and multi-family product throughout the economic downturn, and up to and including this year. This year, even with significantly stronger building activity, we will produce approximately 900,000 to 950,000 single and multi-family dwellings, and again, will underserve the country's needs by a wide margin. We have more than absorbed the overbuilding of the early- to mid-2000s and have been underproducing for a protracted period of time. This shortfall will have to be made up, and the builders of both multi- and single family products have been pushing to increase production as inventories of rentals, existing homes and new homes have remained extremely low, and pricing for all of these products have been moving up. And inventories are likely to remain low as production increases are constrained by a shortage of entitled and developed land to build on. Interest rates, though somewhat higher, are still at historically very acceptable levels. Consumer perception at this point remains that today's low interest rate still presents a unique opportunity to lock in a very low cost of capital, and this opportunity might not be available forever. Even with more significant movement in both interest rates and pricing, homes remain affordable by all measures and will continue to remain attractive relative to rental options as well. Finally, while demand for homes has been constrained by an overly restrictive mortgage market, which has limited access to home ownership with highly conservative underwriting criteria, the landscape continues to improve as lenders are beginning to reconsider their credit underwriting overlays and open the doors for more approvals. While this process has been and continues to be slow to mature, we've come a long way since last year at this time, and we expect to see further easing of credit standards to normalized levels and further extension of credit to the markets. As we've seen over the past quarter, there have been, and still are, economic and political uncertainties ahead that will affect and bring questions to the future of housing. The pending debt ceiling debate, the future of the taper discussion and the international swirl around Syria and the Middle East will all produce bumps in the housing recovery road. We continue to feel, however, that this housing recovery is fundamentally based and driven by a long-term demographic need for dwelling units. We believe we're still in the beginning stages of a recovery that will be sustained for several more years. And strategically, this is how we are positioning Lennar for the upcoming years. Now turning to Lennar specifically, we feel that our company is really hitting on all cylinders. Lennar has been and continues to be very well positioned for current market conditions and recovery in housing. This is reflective in our third quarter 2013 results and in our positioning for the future. In our third quarter, new orders were up 14% over last year, while our new order dollar value of $1.5 billion was up 32% over the prior year. Our dollar value of backlog is up 53%. Gross margins improved year-over-year to an industry-leading 24.9%, a 170-basis-point increase over last year. And operating margins increased 350 basis points to 14.7%, reflecting the powerful operating leverage in our platform. For the fourth quarter 2013, we expect that our gross margins will remain consistent with current levels. Margins continue to benefit from our aggressive land acquisition strategy, as well as higher home prices and operating leverage. While recent sales have seen a mild increase in the use of incentives on selected inventory, margins are remaining steady. During the quarter, we continued our aggressive land acquisition strategy and closed on approximately 11,600 homesites for approximately $610 million. And that land has basically been contracted for between 1 and 2 years prior to its closing. Additionally, we spent $160 million on bringing land to developed status and ready for production. Our average selling price for the third quarter was $291,000, a 13% increase over last year, which covered the increases in labor and material costs which increased approximately 8.4% over the prior year to around $45 per square foot. Lumber costs have been -- have recently come down, but this has been offset by increases in labor. The most labor-constrained categories are framing, drywall, plumbing and concrete. We expect that costs for fourth quarter closings will be slightly higher than our third quarter. But our average selling price of homes in the third quarter was up 16%, and those price increases will continue to cover the increase in costs. Our Homebuilding operations continue to improve due to the strong operating strategy, strong land position, complemented by an excellent management team and management execution. Additionally, we opened 77 new communities and closed out 57 communities during the quarter to end up with -- to end up at 514 active communities, a 16% year-over-year increase. Today, we are fortunate to have land in hand to meet our projected deliveries through 2014 and much of 2015 as well. And as a result, we're pursuing land opportunities for 2015 and beyond. Complementing our Homebuilding operations, our Financial Services segment had another strong quarter, with operating earnings of $23.5 million, down slightly from the $25.3 million last year. Our mortgage company captured some 70% -- 77% of Lennar home buyers within the markets in which we operate. The mortgage operations have benefited from a robust refinancing market in past quarters that -- and that part of the business is now starting to subside. Lennar home mortgages continues to grow, however, alongside our expanding Homebuilding business, as well as serve a number of non-Lennar purchasers in a growing number of markets, making up some of the shortfall from the slowing of the refi business. While our Homebuilding and Financial Services divisions are primary drivers of near-term revenues and earnings, our 3 additional operating segments are all maturing to be excellent longer-term value creation platforms for the company. Rialto continues to grow as a blue chip capital investment management company and commercial real estate capital provider. While current earnings have slowed as we have shifted from the balance sheet investment model to a fund investment model, the prospects for future consistent earnings continue to improve. In Fund 1, we invested approximately $1 billion of equity in 60 separate transactions, and actual performance continues to well exceed our original projections. So in addition to being able to recycle and invest an additional $300 million of capital with only 2 -- within only 2 quarters subsequent to becoming fully invested, we have already been able to distribute $365 million to our investors, or over 50% of their initial capital contributed. In addition, if we continue on our current path, the carried interest to Rialto as manager of the fund will exceed our expectations, and none of that potential is yet reflected in our current earnings picture. While Fund 1 is now fully invested, our opportunistic program has continued uninterrupted through our second real estate fund, which has already closed private equity commitments of almost $650 million compared to the $260 million reported at the end of the second quarter. And this is well on its way towards our goal of raising approximately $1 billion by year end. Fund 2 has already invested over $230 million in 17 separate transactions. And following on the theme of high-return-on-capital businesses, earlier this year, we brought on board one of the industry's most experienced commercial real estate origination groups led by Brett Ersoff and John Herman. Our initial objective for Rialto Mortgage Finance has been to originate and securitize long-term fixed rate loans on stabilized, cash-flowing, institutional-grade commercial real estate properties. And this program is now well on its way to profitability. Although the shorter-term earnings have slowed, we have morphed into a private equity and high-return-on-capital program, and our Rialto program is maturing on plan. We are very excited about the long-term prospects for value creation from this platform. As with Rialto, we're really pleased with the progress of our multi-family rental business. This business began operations in early 2011 and is positioned to become one of the leading developers of new Class A apartments in the United States. We have assembled a seasoned team of professionals that is leveraging every aspect of our company. In the third quarter, we commenced construction on 2 new apartment communities and now have seen -- and now have 7 active projects totaling 2,100 apartments with an estimated development cost of approximately $326 million. Including these active communities, today, we have a geographically diversified development pipeline that exceeds $2.5 billion and over 11,000 apartments. As we've discussed in the past, we're building these apartments with third-party institutional capital, and each deal has been conservatively financed with non-recourse debt. In addition, we have underwritten our investments using today's rents and unlevered yield on costs that are 125 to 200 basis points over the prevailing cap rate. With our conservative financing and underwriting, we're positioned to earn IRRs exceeding 25% and cash multiples greater than 2x. We anticipate that the construction of our development pipeline will be completed over the next 3 to 4 years. As a merchant builder of apartments, we plan to sell our apartments once rents and occupancies have stabilized. Given our construction timeline, we should begin to see returns on invested capital by the middle of 2014 with a more meaningful contribution from the multi-family segment in fiscal 2015. Finally, our FivePoint Communities program continues to mature as a long-term strategy as well and is quickly moving to bring developed land in premium California locations to the market to fill the growing demand for well-located, approved and developed homesites. In the second quarter, we saw the first earnings contribution from this division which will continue to contribute as additional land becomes entitled and developed over the next years. Again, we believe that FivePoint Communities will create excellent long-term shareholder value. In conclusion, let me say that while we are aware of the concerns that are being reflected in current market volatility, our company's strategies continues to be driven by our belief that the market remains positioned to continue to recover, and that our company remains well positioned to benefit. The housing market is healing and recovering, and we -- as we produce shelter that is needed for a growing population and return to more normal levels of household formation. Lennar's Homebuilding operation is extremely well positioned and continues to gain market share. We have excellent land positions in all of our major markets while the overall market is still very constrained, and we have continued to fortify that position. Our Homebuilding operations will continue to be the company's primary driver of current earnings. Homebuilding, of course, is supported and enhanced by our Financial Services division, which will grow in step with the homebuilder and continue to develop its third-party operations to enhance the bottom line. Our ancillary businesses of Rialto, Lennar multi-family communities and FivePoint continue to mature and expand their franchises and will continue to provide longer-term opportunities to enhance shareholder value in the longer term. Although there continues to be political and economic headline risks, the primary drivers of our business are fundamentally sound. I'm confident of Lennar's position in the marketplace today as our strong balance sheet and exceptional group of leaders will continue to be able to navigate through the challenges of today's market landscape and towards opportunities ahead. With that, let me turn over to Bruce.

Thanks, Stuart, and good morning. Our net earnings for the third quarter were $0.54 per diluted share, and I'm going to review the financial highlights, starting with Homebuilding. Our results reflected strong top line growth as our revenues from home sales increased 55% in the third quarter, driven by a 37% increase in deliveries and a 13% year-over-year increase in average sales price to $291,000. That sale price by region is as follows: the East region was $261,000, up 7%; Southeast Florida region was $299,000, up 8%; Central region, $261,000, up 16%; Houston was $272,000, up 15%; the West region was $361,000, up 21%; and other region was $394,000, up 10%. The 24.9% gross margin that was up 170 basis points over the prior year was driven primarily by new communities purchased after 2008, which continued to outperform the company's average gross margin and they represented in this quarter 61% of the company's deliveries. Sales incentives were $18,700 per home in the third quarter, or 6% as a percent of home sale revenue. The sales incentives improved by 330 basis points, or $7,400 per home delivered versus the prior year. The gross margin percentage for the quarter was the highest in the East, Southeast Florida and West regions. SG&A percent as a percent of revenues from home sales improved 180 basis points to 10.2%, and we are realizing significant operating leverage as our Homebuilding volumes increased. That resulted in a 350-basis-point improvement in our operating margin. Additionally, we have seen significant operating leverage in our corporate G&A line as our corporate G&A improved 60 basis points to 2.3% as a percent of revenue during the quarter. During the quarter, equity in the earnings of unconsolidated joint ventures was $10.3 million versus a loss of $6 million in the prior year. This is primarily a result of income related to the sale of homesites at our El Toro joint venture to third-party builders. Turning to Financial Services. As Stuart mentioned, our earnings were $23.5 million in the quarter versus $25.3 million in the prior year. Our mortgage pretax income decreased during the quarter to $18.8 million from $22.3 million in the prior year. As I have been highlighting for a few quarters, we have been expecting the number of refinanced transactions to decline and the profit per transaction to moderate, and we did see that in our results this quarter. Our Eagle Mortgage retail channel experienced a reduction in refinance volume from 49% of the total originations being refinance-oriented versus now 26% in the current quarter. Our Universal American Mortgage Company subsidiary provides mortgages to our home buyer customers and, therefore, almost all of these are purchase transactions. In total, our mortgage operations are now 88% purchase transactions and 12% refinance transactions. This quarter's mortgage originations increased by 7% to $1.4 billion as we have been effective in growing our purchase transactions to offset the reductions in refinances. However, there has been margin compression in the market as a result of more competition targeting the purchase business. Our Title Company had a $5.2 million profit in the third quarter, and this compares with a $3.6 million profit in the prior year. And this is on a 7% increase in revenues. Turning to Rialto. We generated $1.5 million of profits compared to $7.7 million in the prior year. Both amounts are net of noncontrolling interest. The composition of those profits by type of investment is as follows: the Rialto Real Estate Funds contributed $5.2 million of earnings; the FDIC and wholly-owned bank portfolios contributed a net of $2 million of earnings, and these amounts were reduced by $5.7 million of G&A and other, which is net of management fees and reimbursements of $9.3 million. One thing to note, the prior year amount included $15.4 million of earnings from the PPIP program, which was successfully completed in 2012. The FDIC originally provided $627 million of seller financing, which had to be repaid before we could make distributions back to the company. As of today, we now have enough cash in Rialto to fully retire the remaining debt balance, which will allow us to make additional distributions in the coming quarters to the partners. Additionally, it positions Rialto with an underlevered balance sheet. Turning to our balance sheet, our balance sheet liquidity remained strong in the third quarter, with $434 million of cash and $100 million outstanding under our unsecured revolving credit facility. During the quarter, that credit facility was increased to $950 million, and its maturity was extended to June of 2017. Our stockholders' equity increased to $3.7 billion during the quarter, and our book value per share increased to $19.10. Our homesites owned and controlled now total 147,000 homesites. 119,000 are owned and 28,000 are controlled. Our completed unsold inventory remains low, averaging about 1 home per community. I wanted to summarize what's been said on this call and highlight a few additional items for the remainder of 2013. First, we remain comfortable with our backlog, and we continue to expect to deliver between 18,250 and 18,500 homes for all of 2013. This will result in a backlog conversion ratio exceeding 90% for the fourth quarter. Second, the strength of our backlog has given us confidence for our gross margin guidance to be maintained around the third quarter actual gross margin level of 24.9%. Third, Lennar Financial Services' earnings are expected to decrease sequentially from the third quarter as we book our mortgage profits based on loan locks, and this is due to the normal seasonality that occurs in our fourth quarter. And then last, our effective tax rate for the third quarter was approximately 36% as we were favorably benefited by several tax credits which were applicable to the third quarter. And as we look at the fourth quarter, we now expect our fourth quarter effective tax rate to be approximately 38%. And with that, let me turn it back to the operator and open it up for your questions.

[Operator Instructions] The first question is coming from Bob Wetenhall, RBC Capital.

I wanted to ask -- it was a strong quarter in terms of gross margin performance and incremental operating leverage. Could you help give us a sense of where you see gross margins going in the next 2 or 3 years if volumes continue to recover?

So Bob, looking forward, as we think about gross margins, there are several opportunities still for gross margins to grow. We think we have the opportunity for margins to exceed our past peak, which was around the 26% to 27% range if everything goes according to plan. And that's based on the following: it's based on average sales prices continuing to grow as there's still room and affordability; sales incentives still have room to go down from the current 6% level over time to what's more normal at 3%; we have more of our new communities that would come online that have a higher gross margin than the company average. Currently 61% of our deliveries, as I mentioned, were coming from new communities, so that should be helpful as well. And then as absorption increases and gets back to normalized levels, we have the ability to amortize fixed costs over more deliveries. So if everything happens according to plan, there is room for upward mobility in the margins over time. We think the next quarter, however, will probably be somewhere close to the level that you saw in the third quarter that we just reported.

Hey, Bob, this is Rick. Just one other thing I'd point out is, as we have typically discussed in the past, we're more focused on our operating margin than by -- than the gross margin. We're very focused on leveraging the overhead, the infrastructure of the company. We will, within any quarter, adjust pricing and pace to maximize the underlying value of the assets. So gross margins will move up and down, but the real thing you should focus on is the operating margin line.

That's really informative. I appreciate the granular detail. If -- on a follow-up, Stuart had said that interest rates are probably having an impact on order growth, but he characterized the impact as been temporary and mild, and touched on the production deficit. If rates stay in the current context for 30-year fixed, how do you think the recovery looks from here on out during the next 12 months?

Bob, it's our view that the recovery -- it just continues forward. I think that the first move in both sales pace and pricing has been stronger than people anticipated, in large part because it's a reversion as opposed to just a straight-line recovery. When I say reversion, we had a very, very unusual downturn. It was much more severe than we've seen historically, and I think there's been somewhat of a snap back. The fact that the rate of growth in sales and sales price will and should moderate does not derail the recovery. We think that the recovery will be more orderly and slower in nature. But we think that over the next 3 to 5 years, we're likely to be in a steady recovery mode.

The next question is coming from Stephen East, ISI Group.

Stuart, you talked about what you were seeing with demand a little bit, if you could talk a little bit more just what you all were seeing as you went through the quarter and post-quarter for demand and pricing? And then as you go through this a bit slower time, what's your strategy? Or how has your strategy changed a little bit to navigate through this period?

Yes. Let me turn that over to Rick and then to Jon. They have a real close -- they're in close touch with the people in the field, and you'll get a better answer from them. Rick?

As we look at the quarter, Steve, I would tell you that July was the slowest month for us, and we saw August actually being the strongest month on both a nominal and year-over-year basis. That was pretty much consistent with both number of sales and dollar pricing power. There was a little bit of sticker shock associated with the rate increase so dramatically, a little pause on the market, and we saw buyers starting to come back to the market. And as Stuart said in his opening comments and his talk about the economy, we see just strong viable fundamental demand out there. But it's cooled a little bit. As a result of that, we have -- from a pricing standpoint, we've selected some of our inventory, select inventory, and have increased some incentives associated with that inventory. But blended across the overall pool, it's got a relatively modest impact on pricing and net sales price. It varies dramatically by market. The A communities are performing extremely well, and -- but we're really focused on discounting. If there was discounting on stuff that was ready to close and we -- it was just the best way for us to focus on a return on investment. Jon, any further comments?

As we manage through what is apparently more of a normal season, as Bruce highlighted, we're focused on our unsold inventory, which is about one home per community. And we'll manage the levers of price and pace to make sure those homes are delivered, they're sold and they close, and that will create some fluctuations from community to community. But as I look at our backlog and look at the end of third quarter sequentially compared to the second quarter, I feel very comfortable that we are managing our average sales price in a level or upward trend and the same with our gross margin. So I think we managed through this somewhat bumpier time because our inventory is under control -- we're not under pressure to incentivize any greater than the market needs to keep that pace.

And just a final thought on that, Steve. I think this is at the top of the mind of the market right now. What we're hearing from customers in the field, clearly there's a little bit of sticker shock relative to interest rates moving. At the same time, the prices have been moving up. We saw across the country, in the Case-Shiller report this morning, that prices are up in a healthy way. And so, as interest rates have moved, people have had to confront the fact that the price that they were looking at a few weeks ago might be different than the price -- or the monthly payment might be different than today. But by and large, they still have to measure their decision on where they're going to live against rental rates. And they still have to -- and they still have the opportunity to look at reasonably low interest rates that are going to hold them in good stead for years to come. The attitude of the consumer in the field still seems to be positively oriented towards finding a way to purchase and making it through the mortgage maze right now and finding their way into homeownership.

Okay. That's really helpful. And then, if we look, you can grow 1 of 2 ways. You can buy the lots and the land or you can buy the company. There are -- both are pretty fluid right now on the M&A side. We're seeing some small deals, but then we also have the 2 big ones that are sitting out there and the land environment itself looks like it's getting a bit more rational. Can you talk about those 2 and how you all view your appetite for potential M&A? And then, what's actually going on in the land market?

Yes. As has been the case with our company for a very long time, there is nothing that we don't look at and consider. We look at M&A the same way that we look at organic growth. It's all about competing capital, and we measure the returns on capital that we can generate from a company acquisition against comparably deployed capital in a well constructed organic program. And wherever the best returns for our company are going to lie, that's where we act. So there is nothing off the table as it relates to Lennar. We are focused on and have reviewed every M&A transaction that's out there, and we are looking at just about every organic opportunity to purchase new land positions. It's all about returns on the invested capital.

Has the land market changed?

Yes, Steve, this is Rick. The land market has been going through a state of evolution, as we've discussed in the past because there are more ready-to-go, finished homesites out there that have been priced up. That's not to say that you can invest in communities that produce a good return and a decent gross margin. But clearly, not the margins that we've seen in current deliveries. And as a result of that, as Stuart mentioned, most of our land acquisition activity or contracting activity -- and I want to really focus on that -- things that we've been putting under contract are things that we'll probably be closing on in 2015, 2016, 2017. We benefit from the fact that we were early in, aggressive and you can see that reflected in the gross margins.

The next question is coming from Ivy Zelman, Zelman & Associates. Ivy Lynne Zelman - Zelman & Associates, LLC: Two questions, and one question really pertains to incentives. Recognizing, I think, the way you described it, Stuart, is that you're using it selectively where necessary to move inventory. Maybe, Rick, you were the one that said it, 1 per community. One of the concerns we have is that unlike any other cycle we've actually seen pricing spikes at the front end of the cycle and volumes usually are the ones to increase and follow that pricing. So now that we've weaned the consumer with the spike in pricing, off of incentives after 6 tough years of negotiations, aren't you opening up the door for a slippery slope of undermining consumers' confidence in the value of the homes they're buying? And not just you, I'm talking about the industry because there a lot of private builders that want to take their working capital out of the ground, and we're hearing more of them talk about using selling incentives. Although still moderate today, how do you control it? And in prior cycles, have you seen the use of selling incentives after periods where home prices had gone up and then see it resume?

Hey, Ivy, it's Rick. In any market, good, bad, modest, we have used incentives. The industry has used incentives whether it's closing costs, landscape packages, additional spiffs in the home. It's just part of the normal course of business. Those percentages of incentives change depending on the state of the inventory, the development status in the community, and it's just part of the normal course of business in the industry and in our company. What we identified is that we are -- we have started to use a little bit more. And by a little bit, we're talking maybe 1 point, 1.5 points on selected inventory out there in order to get some activity. And it may be 3 or 4 homes in that community, but not necessarily anything beyond that. It's a price leader. It gets activity out to the job.

Let me just back up for 1 second, and you talked about the spike in pricing as opposed to pace and the like. But let's now remember that a large part of this recovery has been defined by very, very limited inventory both in existing homes and in new homes and, frankly, in apartments. And so, it's not surprising to see the recovery reflected more in pricing than in pace because you simply can't get the pace where inventories are low and land is very constrained. And that's what we're seeing out in the field. And then, additionally, you look at the smaller builder component of the overall industry, the smaller builders have not been able to come back in the sizable way that they have in prior recoveries. So as I articulated before, I think that price -- the initial movement in price is somewhat of a spike and a reversion to where pricing might have been in a normalized downturn. We'll see more moderate reflection in price as we go forward. And as the market goes through minor gyrations and corrections on the way to a broader recovery, we think that we'll have to use incentives on a select basis. But the limitation of inventory is going to be definitional to where the market goes and how we price going forward. Ivy Lynne Zelman - Zelman & Associates, LLC: Okay. That was very helpful. One more question. A big bad bear view out there that I'd like you to dispel if possible is that today the housing starts normalizing given the deficit shelter out there with respect to single-family production predominantly if you can drill in on that. Given where your average home price is and many of the builders focused on more of a move up, more affluent buyer. With today's student loan debt and the young adults that historically have been a first-time home buyer, many believe this demand just isn't there with credit constraints and debt burdens that today's first-time entry market won't be there to support a resumption or a normalized level of new construction predominantly on single family. Can you comment please, Stuart, on that?

Yes. Look, I think over the past just few weeks, you've started to see some of the banks in the context of a declining refi market -- you've seen some of the banks start to talk about the adjustment of some of their overlays as it relates to mortgage approvals. I think that everyone, from the banking world to the political world, is acutely aware of some of the impediments to the first-time homebuyer market finding its way back into this housing recovery. And I think that solid work and thinking is being brought to bear in the market. It doesn't mean we're seeing broad swings of first-time homebuyers being able to find mortgage approval. But I think, as we look ahead, we're likely to see that open up, open up first at the margins and then revert to normal levels of underwriting standards, which should enable first-time buyers to get back into the market and open up the market in general. Ivy Lynne Zelman - Zelman & Associates, LLC: Will you provide the lots for that entry-level buyer with respect to recognizing whereas today your average home prices are? Strategically, do you feel that that's a market that you'll expand as the market fluctuates or the credit loosens? How should we think about the industry's penetration of that market? Is it fluid?

Well, I think -- look, we have a diversified offering, a diversified program and have over decades now. We have a sizable first-time buyer component. We'll continue to focus on that part of the market as opportunity opens up. And we'll remain focused on gross margins as well. I guess the question is, does that mean that as you average in first-time buyers, does average sales price start to decline somewhat as a matter of averaging and I guess we'll have to wait and see how big a component it is. But remember, we are bottom-line return-on-capital-focused. And so, where opportunity presents itself, we'll be focusing on our operating margin first and foremost.

The next question is coming from Stephen Kim of Barclays.

So there's been a lot of talk on incentives. I think you guys obviously did a good job, better than we were fearing actually in the quarter on incentives actually coming down. But I guess, in general, you've talked about stepping up the incentive activity a little bit here. Can you give us a sense for what the response has been so far on the part of buyers to this very selective increasing of incentives on standing inventory?

Let me have Jon and then Rick take that.

I think you can see, by the fact that we have very little standing inventory, that we have used those selective incentives very carefully and very effectively. And they are a lever that each of our divisions exercises community by community, home by home to make sure we're accomplishing that goal. But I think we feel very comfortable that we're -- we have the right amount to move the inventory that we want to make sure we move. So as we get to month end and quarter end, we're in a very similar position that we're in now.

Yes. Steve, as you look at the operation of the business, the incentives for the consumer haven't really moved the needle per se. It's really a way for us to generate activity from the brokerage community, and it's a traffic generator. When people come out to the communities, they still find sentimental value. And whether there is an additional 1%, 0.5%, 2%, it's not what is impacting the investment decision.

Just let me add as a third thought here. In the context of sticker shock, everybody wants a deal, everybody wants to feel that they've lost a little bit and they're getting a little bit back. So it's just an ignition point right now to just keep the market kind of attentive in the context of a time when pricing moved on people.

Yes. That's very helpful. Another question that I had -- I guess a second question, sort of a broader question about your opportunities that you see currently in the land market and for your company generally. You've talked about the fact that you're stepping up and you've been very active on the land purchasing side. We can see that in the numbers that you've provided, much higher levels than relative to your burn rate, if you will, than is -- would be considered sustainable, and that I would say almost double what would be considered sustainable. So clearly, there's a cyclical component to what you're pursuing. But you've also talked about shortages in the land market more broadly. That struck me as being also somewhat cyclical and, therefore, somewhat temporary. And I'm curious as to whether you can comment on how much longer you think the land market is going to be in its current severely constrained state so that it would justify your accelerated level of land purchases. We're talking 2 years, 3 years? Do you think this is somewhat systemic? If you could just give us some sense of that, that would be great.

Okay. You're clearly noting that we've remained an aggressive purchaser of land. As we've noted, this started a number of years ago. We were early to the land purchasing program, and we've maintained that early position -- the properties that we're closing on in large dollar amounts today, the properties that we've contracted for at a much earlier stage. We remain focused on the land side of the business. The land market is constrained, and we would rather be buying early rather than late. We have a 3- to 5-year time horizon on this recovery. We've articulated that, and that defines and informs a good portion of our strategy. To your question about how long will the land market remain constrained, of course, I can't answer that definitively, but it's been -- our view has been formed by the fact that like the smaller homebuilders, the land developer business has had difficulty gaining access to capital except through opportunity-type funds where the cost of capital is rather steep. And so, this acts as its own constraint to the expansion of the supply of land inventory in the marketplace. So at least, for the foreseeable future, until capital markets find a way and with non-opportunistic capital to open up to land developers, we think that land continues to remain constrained and, therefore, constrain inventories overall.

Let me just add one more thought to Stuart's comment is that compared to the last cycle, the environmental, in an entitlement situation, the conditions are much stricter than they were last cycle. So that's going to add to the capital situation land developers face, and I think continue to have a slightly more constrained land environment as we move forward.

And, Steve, I guess, the final point is, strategically, assuming that there is a new level of development -- third-party development activity coming on stream 2 years, 3 years out, it really plays strategically with how we've invested our capital because we have the ability to supplement our core purchases with incremental immediate delivery opportunities as the market unfolds and starts to continue to grow. And we think that it's consistent with what our overall strategy has been from the get-go.

The next question is coming from Jade Rahmani, KBW. Jade J. Rahmani - Keefe, Bruyette, & Woods, Inc., Research Division: Just a quick one on your average sales price. Given the average order price, do you expect the average sales price on deliveries in the fourth quarter to be in the $300,000 range?

Yes. Jade, if you look at our backlog average sales price, it always runs a little bit higher than what we actually deliver because the larger homes sit in backlog a little bit longer. So we would expect there to be a slight increase in the average sales price going into the fourth quarter. Jade J. Rahmani - Keefe, Bruyette, & Woods, Inc., Research Division: Okay. And just on Rialto. I think you mentioned the balance sheet is underlevered with the FDIC debt having been fully defeased. Can you talk about options to add leverage? And on Rialto Mortgage Finance, when do you think that the CMBS loan conduit originations would commence in full and start contributing to earnings?

Yes. Well, look, I think that we have created a terrific optionality in our subsidiary operations. And clearly, that's one point of access to capital that we have in our arsenal. Rialto is really well situated today, having defeased the FDIC debt, with a very strong balance sheet. It's positioned as a stand-alone enterprise that is separately reported. We have all of the levers available to us. Jade J. Rahmani - Keefe, Bruyette, & Woods, Inc., Research Division: Okay. Available for the addition of leverage?

Leveraged equity -- we've really maintained maximum flexibility in terms of -- by segmenting the business. And as we've grown the business in an unlevered way, we've just afforded ourselves maximum flexibility to go in a number of different directions. Jade J. Rahmani - Keefe, Bruyette, & Woods, Inc., Research Division: And the loan conduit, do you think that is something that would contribute to earnings in 2014?

As I noted in my remarks, we have brought on an exceptional team in that space. It is -- they've been working hard getting positioned. While we haven't projected profitability, we think that we're well positioned for profitability in 2014.

The next question is coming from Michael Rehaut at JPMorgan Chase. Michael Jason Rehaut - JP Morgan Chase & Co, Research Division: First question I had was on sales pace. So far this year, you've been doing plus or minus 3 to 4 a month on average. And as far as my understanding, generally, builders will typically look for, depending on the market, et cetera, 4 per month is a pretty good yardstick, maybe sometimes a little more depending on the ASP and the density. Is there something that you're comfortable with at this stage in the cycle? And as we get more towards, let's say, the middle part of the cycle, would you see that sales pace change at all materially?

Well, listen, absorption rates are a cyclical phenomenon. I think that if you look at our absorption rate for this quarter, it was somewhere around 3.2%. If you look at last quarter, the spring selling season, we were closer to 4%. And sales pace moves around a little bit, as you go through the seasonality of the year. So I think we're comfortable with where our sales pace has been, and we feel that, again, the market continues to be pretty solid.

The other thing I'd like to add to that, Michael, is as we purchase communities and underwrite communities with various absorption paces depending on the type of asset that we're buying, and they range from sort of higher end, more affluent type of opportunities where maybe we're looking at an absorption pace of 1.5% to 2% because the operating margins on those closings are so significant, and it justifies the investment of capital. Then there are some communities that we're projecting 4, 5, 6, 7 because it's more of a volume-oriented opportunity. And what skews some of the pace that you see quarter-to-quarter is the mix of deliveries that we're closing from the communities that we have across the country. Michael Jason Rehaut - JP Morgan Chase & Co, Research Division: No, I understand and I appreciate that. It's kind of why I gave a range of 3 to 4 and understanding seasonality. I guess I was just thinking more from the perspective that there are other builders, let's say, that have kind of put sales pace out there and said, "Hey, you know, relative to the early 2000s, late 1990s, overall, we're still 25%, 30%, even off of our what we consider a normalized sales pace with all those factors considered." I was just wondering if that's a statement that applies to you or that, again, given the mix and everything else, that the sales pace that you're currently seeing is something that you would expect either more in the middle of the cycle or maybe that's just not the case for you that you're more or less hitting what you were hoping to hit as the communities are coming through?

Well, I can tell you that we're exceeding underwriting with regards to pace for the most part. That on a historical basis, absorptions have been higher at various points of cycles and we run the business to maximize the operating margin in the individual communities.

I would just add that we manage our pace also to match our construction pace. And again, we've mentioned a few times about our low level of spec homes. We really don't want to sell at a faster pace than we're constructing homes. And that, of course, is somewhat controlled by our community count and the land supply that we've spoken about. Michael Jason Rehaut - JP Morgan Chase & Co, Research Division: No, I appreciate. That's helpful. I guess, second question just on equity earnings in Rialto, the $10 million of profit in the equity earnings line, I guess, from some additional sales of homesites from El Toro, when you reported the profit from El Toro last quarter, I believe then you said that you would be releasing the next phase somewhere over the -- in mid '14. Just thinking about that, going forward, is that something that, the $10 million or this additional flow of lot sales, is that something that we should expect to be a little bit more regular? And also -- I'm sorry to kind of bring in another question. But on Rialto, now that you've defeased the debt, should we expect a different flow of earnings from the -- now that the distributions might come in a little bit more on a regular basis?

Let me answer the first question, Mike. With respect to the joint venture profit, we didn't sell additional homesites than the 726. There was some profit relating to the 726 homesites that were booked in this quarter. We still believe that the next group of homesites at El Toro are about, call it, sometime in 2014. So we didn't elect to sell additional homesites at this point. And then, relative to additional earnings in Rialto, because the debt's defeased, there's nothing there. So that doesn't pair up well relative to the debt being defeased. So as far as earnings go going forward, there'd be no change.

The next question is coming from Eli Hackel, Goldman Sachs.

Just 2 questions. First, Stuart, you mentioned a little bit more on banks loosening up. Can you just give a little bit more color? It sounded like in the last couple of weeks you noticed a change, have you seen anything related to just them saying, well, QRM is here, refi revenue is down, wanting to make that up? And then, just on the incentives, I know you talked about it a little bit, but is there any region or price point that was more prevalent in?

Bruce, why don't you go ahead? I think as it relates to the banks, the banks have made their own announcements.

Yes. I'm sorry. Could you just repeat that first part, Eli?

Sure. Just in the beginning of some prepared remarks and some questions, just from banks maybe potentially loosening up a little bit more. You said you noticed some signs of that. I just was hoping for a little bit more color there, and then sort of how fast could that -- maybe it speeds up, but the refi revenue is down 50% or 60%. I just wanted your thoughts there.

Yes, sure. So what we did here with some of the major banks is that FICO scores have been announced that they've been reduced into the low 600 range. And then, additionally, in several states, the down payment requirement has come down to as low as 5%, and that is something that we believe is being implemented over the next month. So you're starting to see some benefit there. And in addition to that, you're also seeing that there's more mortgage insurance that's being used. In this quarter, over 1/3 of our conventional buyers had down payments less than 20%. And down payment is the biggest issue for our buyers typically. So we think that's very helpful for what's already changed and what's coming down the pike over the next month or so from the banks. So as refinance volume, as you mentioned, continues to trail off, that's a big component of bank earnings as we all know, and you're seeing the layoffs out there. And so, the tendency would be we would expect for a continuing easing with some of the overlays that they've had in place. So we look at that as real positive going forward.

But I think you've actually seen JPMorgan and Wells make announcements that their underwriting standards are starting to moderate, especially as that refi business has bled off.

Right.

And then, just on incentives, just if they were concentrated in a region or price point?

The incentives have been pretty widespread -- I mean, across the country and have been in select communities, where they might have been needed as a re-spark.

The next question is coming from Ken Zener, KeyBanc Capital Markets.

So your guys' delivery can come through more communities or greater sales pace. If the sales pace is going to follow vagaries of the market, and it seems where it is seasonal versus cyclical right now. Can you -- with all your land in hand, can you give us -- or comment on '14's expected community count -- growth rate right now?

We haven't laid that out at this point, Ken. That's -- we're intending to give an update into 2014 on our next conference call, which we're expecting to be about the 3rd week of December.

Okay. And then, the second point. With your closing guidance suggesting mid-90% backlog turn, it obviously indicates quite a bit of pre-built homes already in inventory. So does that -- 2 questions here, does that approach -- is that more common in less land-constrained areas, or are you actually using that kind of pre-built but not sold on the price as the way to kind of leverage price gains, kind of call options for your margins. What's in that, is there -- it's an obvious margin spread between your pre-sold homes as opposed to ones you started building and then sold them?

Well, on the inventory side, I think we've consistently said over time that we have a spec program where we try to maintain 1 to 2 per community across the country in every community. We have some that are starting construction, some of which is presold, some of which is a speculative unsold home. And what we do is, on each community -- at each community, we measure pace and price to figure out what our start program would be. And we haven't really adjusted that program in the market over the last several quarters, pretty consistent with what we've been doing.

Right. And with that, why don't we make this -- the next one the last question?

And our last question is coming from Susan Maklari of UBS.

My first question is on the cancellation rate. Can you give us a little more detail into what caused the sequential increase that we saw? And then, are you comfortable with the current level? Or how should we think about the potential trends in that going forward?

Well, our cancellation rate has really been pretty modest. If you look historically, cancellation rates are generally around 20% and maybe even trending a little bit higher. We've always articulated and felt that not having that kind of level of cancellation rate means that our sales folks just aren't pushing or working hard enough. You're going to have a certain number of buyers that, for one reason or another, don't go forward. So our cancellation rate, at least by historical norms, is still relatively low. We're in the 18% range right now. So I wouldn't ascribe too much importance to that cancellation rate for the fluctuations around that range. Bruce, would you add to that?

No, no, I agree. I think you said it well. We've always said that normalized cancellation rate is around 20%. And when there was a buildup of inventory and we needed to monetize inventory in the downturn, it got up to much higher levels. But we would like to see the can rate be at a healthy level, closer to that 20% range, give or take a little bit.

Okay. Perfect. And then, just one last question. You spoke to the fact that you're still able to offset the input cost increases that you're seeing with the home price appreciation that you're getting. If we get to a point where the home price depreciation falls somewhat from what we're seeing, can you talk about maybe potentially some of the things you can do to help offset those input prices and continue to maintain somewhat the margins that you're seeing now?

Okay. So as input prices are changing, again, we've been offsetting them with our price increases and with sales incentives coming down. And keeping in mind that our direct costs are 40% to 45% of the sales price, so they would have to go up twice as fast as any net benefit between the sales price improvement or the sales incentives coming down. So that's the main item that we see offsetting these costs as we go forward.

But additionally, we are primarily focused on our operating margin. And as our volumes continue to improve and as our efficiency continues to improve, we think that the net bottom line is also improving even as sales price starts to slow a little bit. All right. So we'll end it there. We would like to thank everybody for joining us for our third quarter update and look forward to reporting the fourth quarter. As Bruce said earlier, it will be the 3rd week of December, and we look forward to telling you more about the progress of the market and our company. Thank you.

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