Lennar Corporation

Welcome to Lenore's first quarter earnings conference call. At this time, all participants are in a listen-only mode. After the presentation, we will conduct a question and answer session. Today's conference is being recorded. If you have any objections, you may disconnect at this time. I will now turn the call over to Alexandra Lumpkin for the reading of the forward-looking statement.

Thank you and good morning. Today's conference call may include forward-looking statements. including statements regarding Lenar's business, financial condition, results of operations, cash flows, strategies, and prospects. Forward-looking statements represent only Lenar'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 LNAR'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 LNAR's Annual Report on Form 10-K Most Recently Filed with the SEC. Please note that LNAR seems no obligation to update any forward-looking statements.

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

Great. Thank you. Good morning, everybody. This morning, I am here with Rick Beckwith, our Chief Executive Officer, Diane Bessette, our Chief Financial Officer, and of course, David Collins, our Controller. John Jaffe, our President, is joining by phone. I'm going to start with a brief overview. Rick and John will give a brief operational overview. And Diane will deliver further detail on our first quarter results as well as some additional guidance for 2019. As always, when we get to Q&A, I'd like to ask that you limit your questions to just one question and one follow-up so that we can accommodate as many participants as possible. So let me go ahead and begin and say that while the housing market continued to be choppy throughout our first quarter, we are pleased to report very solid results. Although we had slightly lower than expected deliveries and revenues, we achieved somewhat better than expected sales and margins as we did see strengthening as the quarter progressed. Generally speaking, it seems as though the market paused in the back half of 19, corrected in the first quarter, and is now on solid footing as we begin the 2019 spring selling season. Looking backwards, the housing market continued to slow through the fourth quarter of 2018 as higher home prices and rapid interest rate increases combined to create a mismatch between prices and buyer expectations. Through the first quarter, interest rates moderated and home price appreciation stalled and even pulled back. We clearly saw traffic and sales accelerate through the first quarter as strong employment, wage growth, higher participation rate, consumer confidence, and economic growth drove the consumer to return to a more affordable housing market. Given this progression, we continue to believe, as we said last quarter, that the market took a natural pause It has now adjusted and recalibrated, and we're optimistic that demand, driven by fundamental economic strength, will continue to accelerate through the spring selling season. We've noted consistently that the housing market is primarily driven by the deficit in housing production that has persisted for over a decade. This production deficit continues to define an overall shortage of housing in the country and has acted as a stabilizer as affordability has been tested. Supply of dwellings, both for sale and for rent, continue to be short, and underlying demand driven by the need for a place to live remains strong. Against that backdrop, Lennard performed well in choppy conditions. While deliveries missed the low end of guidance by 2%, this small miss was simply a shift in timing. attributable to well-documented unusual weather conditions around the country. New orders, on the other hand, exceeded the upper end of our guidance by 5%, driven by improving demand progressively through the months of the quarter. We achieved net earnings of almost $240 million this quarter, and our strong cash position enabled us to opportunistically repurchase another 1 million shares of stock and end up with a deficit total cap ratio of 38.5%, which is a 580 basis point improvement over last year. We expect to generate strong cash flow for the remainder of 2019 and expect to continue to use excess cash flow to both pay down debt while opportunistically repurchasing stock. Additionally, Our significant technology initiatives around the company continue to be a significant reservoir of opportunity as we enhance our customer interface, create efficiencies in internal operations, reduce our SG&A, and reduce our cost structure as well. We continue to be laser focused on progress on our technology adoption and change management as this is being incrementally reflected in bottom line improvements. We are still at the very beginning of the opportunities that we envision as we build a better mousetrap. On a final note, we've continued to focus on reverting to our core home building platform by repositioning or opportunistically monetizing non-core assets and business lines in order to drive efficiencies and enhance cash flow. In the first quarter, we completed the sale of our real estate brokerage business as well as the sale of the majority of our retail title business and underwriter and our retail mortgage business. Additionally, we've contracted to sell our hospital in the Midwest, a remnant asset from Rialto, and that asset's expected to close in the second quarter. Before I turn over to Rick, John, and Diane, let me just say that even with what has been a choppy housing market, we're very excited about our position and our business strategy, and we're encouraged by recent market signals about the remainder of the year. Of course, we benefit from the size and scale we have amassed in each of our strategic markets, and that's reflected in our consistent improvement in SG&A. Through 2019, we'll be generating strong cash flow and bottom line profits and we're continuing to use cash to reduce debt. Our balance sheet is strengthening while we use the weakness of market to opportunistically repurchase shares. We are shedding non-core assets to generate additional cash and to partner with tech companies who can help enhance our customers' experience while reducing overhead. As the home building market continues to stabilize and redefine itself in the wake of the recent pause, we are optimistic about the remainder of 2019. While Diane will give further Q2 guidance and some additional general direction on our full year expectations, based on our existing land position, our operating strategy, and our dynamic pricing model, we will reiterate that we fully expect to deliver between 50 and 51,000 homes in 2019, with increased efficiency, improving margins through the year, and with strong bottom line profitability and cash flow. And with that, let me turn over to Rick.

Thanks, Stuart. In spite of somewhat softer market conditions, we achieved strong top and bottom line growth in the first quarter. Revenues for the first quarter totaled 3.9 billion, representing a 31% increase from 2018. This was largely driven by a 30% increase in deliveries to 8,802 homes and a 4.1% increase in average sales price. Deliveries for the quarter fell short of our Q4 guidance and were negatively affected by development and construction delays driven by adverse weather conditions across the country. These deliveries will shift into our second quarter and some of our scheduled second quarter deliveries will shift into our third quarter. We expect to return to a more even flow production schedule with non-weather affected build times by the end of Q2. However, notwithstanding construction weather delays, the accelerated starts in Q1 and successfully got on track with our internal start projections cumulatively through the end of Q1. Our gross margin totaled 20.1% in the first quarter. While this was on the lower side of our prior guidance, it was consistent with our Q4 announced strategy to price our inventory to market and to keep our production machine going. We continue to believe that this is the right strategy and that higher operating margins and IRRs will increase shareholder value. Our SG&A in the quarter was 9.5%. This marks an all-time first quarter low and highlights the power of our increased local market scale and operating leverage. Home building operating earnings on the sale of homes totaled $383 million in the quarter, up 48% from the prior year. Our operating margin increased 80 basis points year over year. We're particularly proud of the fact that our core home building earnings are growing at a much faster rate than revenues, once again demonstrating our increased operating efficiencies. Net earnings for the quarter totaled $240 million, up 76% from 2018. New orders for the quarter totaled 10,463 homes, exceeding the high end of our Q4 guidance by 5%. Orders in the quarter were up 24% from the prior year, with a dollar value of approximately $4.2 billion, representing a 23% increase. On a pro forma basis, new orders were down 4% from 2018, tied directly to a 4% decline in active communities from the prior year. The harsh weather in the quarter delayed many community openings, but we should be on track by the beginning of the third quarter with community counts. As I mentioned last quarter, the combination of higher sales prices and mortgage rates moderated demand in our fourth quarter, leading to reduced traffic, lower absorptions, and increased sales incentives. During our first quarter, we saw a reversal of these trends, driven by significantly lower mortgage rates and lower sales prices and or moderating sales price increases. These market changes spurred an increase in traffic on both our website and at our welcome home centers. We saw this activity come first through our digital marketing programs, and on-site community traffic picked up quickly thereafter. The combined impact of this increased traffic led to sequential increases in new orders in each month of our first quarter, with improved year-over-year performance in each month. Most importantly, we experienced this sequential order growth in every one of our 37 home building divisions. While some of this activity is clearly seasonal, we have seen a noticeable shift in home buyer sentiment. In addition, while we did increase sales incentives in the first quarter by 20 basis points from the fourth quarter, we are optimistic that we've reached an inflection point and that incentives will start to decline as we enter the heart of the spring selling season. In any case, we continue to price the market and use our dynamic pricing model to maximize price with the strategic focus on volume and higher operating margins over gross margins by themselves. We ended the first quarter with a sales backlog of 17,259 homes with a dollar value of $7.1 billion. This backlog, combined with our current housing inventory, puts us in a great position to achieve strong operating results in 2019. I'd like to briefly discuss the recent changes by FHA designed to tighten the underwriting standards on FHA-originated loans. FHA now requires lenders to manually underwrite loans that have both debt-to-income ratios above 43% and FICO scores below 620, rather than rely on the automated underwriting system. This is a reversion to a policy that was in place from 2013 to 2016. While the loans can still be approved, the manual process takes slightly longer as it requires additional verifications, calculations, and qualifying hurdles. The net impact of these changes to LNR is insignificant. Based on our analysis of the loans that our Eagle Mortgage Company has made over the last five quarters, we believe that less than 1% of our total loans would have been impacted by these changes. Before I turn it over to John, let me give you a brief update on our land initiatives. The three strategic initiatives we discussed last quarter are up and running. Each vehicle is actively pursuing and underwriting new opportunities and moving forward with the entitlement and development of their previously existing portfolios. In addition, we have expanded the geographic territory of two of these existing structures to include markets outside of Florida. This expanded footprint will increase our asset-light land strategy in many more of our home building operations. Lastly, we are continuing to use these existing structures and are in advanced discussions with several regional developers in other markets to expand this program. Now I'd like to turn it over to John.

Thanks, Rick. Today I'm going to give an update on synergies, direct construction costs along with our production-first operating platform, and our SG&A leverage. First, we remain on track to achieve our prior guidance for 2019 of $380 million for merger synergies, with $265 million of this from direct construction cost savings and $115 million from corporate and SG&A savings. Next, I want to give some perspective on what we are accomplishing with our production first focus, what many of you refer to as pace over price. We have discussed for several quarters our goal of becoming the builder of choice for the construction trades. We articulated a program where we would utilize our significant size and scale in each market to forge new working relationships with our trade partners. We have made the effort to work hand in hand with our trade partners to better understand how together we can maximize efficiencies that improve the bottom line profitability for our trade partners while lowering our construction costs and improving cycle time. Simply put, we've been on a mission to be the low cost to serve builder for the trades so they can in turn share these benefits back with us. We're beginning to see anticipated results from these efforts. Sequentially for the first quarter, Over the fourth quarter, we had a very small increase of just 0.6% in our average construction cost per square foot. This is meaningful as the industry still faces the headwinds of the ongoing labor crisis, which puts pressure on labor costs along with material cost pressures that come from tariffs, factory labor shortages, stricter energy codes, and all without the benefit of the lower lumber costs, which will materialize later in the year. As we highlighted last quarter, we are focused on our production machines, Delivering to the trades even flow starts and deliveries throughout the year. We presented this plan to the trades in all of our divisions and delivered on the plan in Q1 by starting the homes we committed to. As Rick noted, we had to deal with some extreme wet weather conditions that interfered with the goal of evenly spreading our production, but we still delivered on the commitment to start the homes we said we would. We heard from many of our trade partners that we stood out in maintaining our starts during the fourth and first quarters, while many of our pairs pulled back on starts as sales slowed during this time. The combination of working with trades as strategic partners, our commitment to even flow production, and the simplicity of everything included, all work to create an environment where more and more trades are concluding that Lennar is their builder of choice. With our combined size and scale, we were able to leverage our SG&A to an all-time first quarter low of 9.5%. A big contributor to this improvement is our continued focus on the sales process which has reduced our average realtor commission down to 2.27% in Q1, an improvement of 26 basis points year-over-year, and 12 basis points sequentially from Q4. This reduction in cost is the result of our efforts to reach our customers early in the process through our digital marketing campaigns. We had over 190,000 total Internet leads in Q1, a year-over-year increase of 32%. An Internet lead is someone who specifically requests information from us. These leads are attended to immediately by one of our internet sales consultants who are based in each one of our divisions. Their responsibility is to help the customer decide which community is right for them and then set an appointment for the customer to visit that community and follow up with the customer to remind them of their appointment or to reschedule it as needed. This produces a high quantity of high quality leads for our community-based new home consultants and on a scheduled appointment basis. I'll conclude by noting the plan to improve our net operating margin, free cash flow, and return on capital is proving out. Its execution is built on four pillars. One, our builder of choice production first operational platform, which drives cost down. Two, a just-in-time selling platform driven by our dynamic pricing model, which allows us to always be priced to current market conditions. Three, a technology-driven, efficiently levered overhead structure. And four, our everything's included platform that simplifies the home building process while providing great value to the home buyer. I'd now like to turn it over to Diane.

Thank you, John, and good morning to everyone. So let me summarize and reemphasize a few points from our first quarter. And so starting with home building, as you've heard, looking at deliveries, Our actual Q1 2019 deliveries increased 30% from the prior year Q1 2018 deliveries and decreased 12% from pro forma Q1 2018 deliveries. These pro forma deliveries included Cal Atlantic's December 2017 deliveries, which was the last month of its fiscal year and thus not truly comparable. Our first quarter gross margin on home sales was 20.1%. The prior year's gross margin was 19.5% or 21.6% excluding Cal Atlantic's purchase accounting write-up of backlog and construction progress. Our Q1 2019 gross margins were impacted by an increase in sales incentives consistent with our focus on PACE and an increase in construction costs due to the high point of lumber prices in 2018 flowing through Q1 deliveries. As you've heard us say, our first quarter SG&A was 9.5% compared to 9.7% in the prior year. The decrease was due to improved operating leverage as a result of increased size and scale, as well as our continued focus on obtaining benefits from our technology initiative, as John detailed. And then turning to new orders, new orders increased 24% and new order dollar value increased 23% for the first quarter, primarily a result of the California acquisition. Our Q1 2019 new orders decreased 4% from pro forma Q1 2018 new orders, and community count decreased at the same rate, and thus absorptions were flat year-over-year pro forma year at 2.7. Our Q1 cancellation rate was about 17%. And finally, for Q1 2019 home building, joint venture, land sales, and other categories, we had a combined loss of $13.2 million, compared to 154.5 million of earnings in the prior year. But remember that last year included a gain of approximately 165 million related to the sale of an 80% interest in one of our home building joint ventures. So then turning to financial services, again as you heard us say, consistent with our reversion to pure play home builder, during the first quarter our financial services segment sold the majority of its retail title agency business and title insurance underwriter, its retail mortgage business and its real estate brokerage business. But these transactions resulted in a net gain of approximately $1.6 million. As a result of these strategic transactions, financial services headcount has been reduced from approximately $3,200 at year end to approximately $1,700 after the completion of these transactions. And then just to add a little more color on the largest transaction, which was the sale of our retail title agency business and title insurance underwriter. So we sold the majority of these operations to state's title, as we've previously announced. In connection with this transaction, we provided seller financing and received a substantial minority equity ownership stake in state's title. A combination of both the equity and debt components of their transaction did not meet the accounting requirements for sales treatment. And therefore, as you look at our numbers, you'll see that we were required to consolidate state's title results at this time. So then looking at the components of financial servicer, operating earnings net of non-controlling interest related to state's title combined were 21.8 million compared to 25.9 million in the prior year. And the detail of the components is as follows. Mortgage operating earnings increased to $14.9 million from $14.5 million in the prior year. Total originations were relatively flat at $1.9 billion for both Q1 2019 and Q1 2018. Originations in Q1 2019 included increased volume related to a full quarter of Cal Atlantic offset by a decline in volume due to the sale of the retail business. title operating earnings increased to $5.9 million from $5.4 million in the prior year. Even though there was a decrease in the number of title transactions due to the businesses sold, operating earnings increased as a result of additional transactions related to a full quarter of CalAtlantic and a focus on cost reductions to right-size the business. And then one point to note regarding financial services, In connection with the Rialto investment and asset management platform sale in the fourth quarter of 2018, Rialto Mortgage Finance, or R&F, has moved into our financial services segment. And as such, all prior period information has been adjusted to conform with the current presentation. And so looking at R&F for the first quarter of 2019, their operating earnings were about break-even compared to $6.5 million in the prior year. This decrease was due to lower securitization volume and margins during the quarter as compared to the prior year. And then looking at multifamily, in the first quarter, our multifamily segment had operating earnings of 6.8 million compared to an operating loss of 1.2 million in the prior year. In this first quarter, we recorded 15.5 million related to sales during the quarter and 1.8 million of promote revenue related to the stabilization of properties in our L&V fund. As we've noted for a while, we have been moving from a build to sell to a build to hold platform, earning fees and promotes by creating value within our fund. And then finally, other, just a small note, you'll see that new category on our balance sheet in P&L. So as a reminder, we've combined the remaining Rialto assets, which are primarily the fund investments, and our strategic technology investments into this category affected December 1st. Earnings were $3 million in Q1 2019 compared to $4 million in the prior year. Turning to the balance sheet, at February 28th, we ended the quarter with $853 million of cash. We had borrowings on our revolving credit facility of $725 million, leaving about $1.5 billion of available capacity. At quarter end, our home building debt to total cash was 38.5%. And during the quarter, as Stuart mentioned, we repurchased 1 million shares for a total of approximately 47 million. At the end of the quarter, our home sites owned and controlled were 278,000, of which 210,000 are owned and 68,000 are controlled. And stockholders' equity increased to 14.8 billion, and our book value per share grew to 45.75 per share. So now turning to guidance. I'd like to provide some guidance for the second quarter, starting with home building. We expect new orders between 14,000 and 14,300. We expect to deliver between 11,700 and 12,000 homes. We expect our Q2 average sales price to be between 400 and 405,000. We expect our Q2 gross margin to be in the range of 20% to 20.5%, and our SG&A to be in the range of 8.5% to 8.6%. And for the combined category of home building, joint ventures, land sales, and other, we expect a Q2 loss of approximately 10 to 15 million. And then turning to our ancillary businesses, we believe our financial services earnings will be between 45 and 47 million. We believe our multifamily earnings will be about a $5 million loss. And so the other category related to the Rialto legacy assets in our strategic investments, we expect a Q2 loss of approximately $10 million. We expect our Q2 corporate G&A to be about 1.6 of total revenues and our tax rate to be about 25.5%. Our share count should be about 321 million shares. This guidance should produce an EPS range of $1.07 to $1.20 for the quarter. And then turning to fiscal 2019, given that we believe the market is a bit less uncertain and on more solid ground, we thought it would be helpful to provide a few additional data points for the full year 2019. This guidance is still preliminary, and we will adjust as the year progresses. So starting with deliveries. We expect, as Stuart mentioned, to deliver between 50 and 51,000 homes. We believe our average sales price will remain relatively flat from current levels, so approximately 400 to 405,000. Our gross margin is expected to be in the range of 20.5 to 21%, and our SG&A in the range of 8.3 to 8.5%. And then finally, a couple of comments regarding our ancillary businesses. Financial services earnings should be in the range of $185 to $190 million. And then our multifamily earnings should be in the range of $5 to $10 million. This reflects our migration from a build-to-sell to a build-to-hold platform. This strategic change means that instead of having gap earnings as we sell assets, we will have additional accumulation of profits that will be recognized in the future as assets are completed and stabilized. The estimate of our share of accumulated changes in fair value is approximately $150 million on 21 completed and stabilized assets in our LMV Fund 1, as we compared the market value of our investment to our basis. As additional assets complete and stabilize, this amount should increase. So in summary, we believe we are well positioned to have strong profitability and cash flow generation in 2019, and we look forward to reporting our progress in future quarters. And so with that, I'd like to turn it over to the operator for questions.

Thank you. We will now begin the question and answer session. If you would like to ask a question, please press star followed by the number one on your phone, unmute your phone, and record your name clearly when prompted. Your name is required to introduce your question. To cancel your request, press star followed by the number 2. Our first question comes from Buckhorn from Raymond James. Your line is now open.

Thanks. Good morning and congrats on the strong start to the new year. Just could you start with walking us through the map and just kind of characterize what you're seeing in terms of demand trends, absorption paces geographically and maybe by price point and just any other factors with certain markets, for example, foreign buyers in California is an example. Any color there is helpful.

This is John. Particularly in California, we saw in the first quarter the same pattern Rick described nationally, which was each month sequentially we saw an improvement in traffic and the quality of that traffic and in sales. And we saw what we expected, which would be a recovery first in the more affordable California markets of the Central Valley and Sacramento, and a slightly slower recovery in the more expensive coastal markets, Bay Area, Orange County, and San Diego.

You know, and as I said, this is Rick, as I said in my comments, we saw sequential increases. each month, each quarter in every division that we had. From an overall standpoint, we started in the December month with a negative comparison year over year and got finally to, in February, a positive variance that netted 2 or 4% down for the quarter. You saw increases in absorption pace month to month to month throughout the quarter. and that was pretty much across every market that we saw.

Okay. That's helpful. And so it sounds like the trends in the margins or the margins in the backlog are stabilizing and or improving. I'm just wondering, is that a function of any changes in the product mix you're making, or is that expectations of reduced incentives going forward that would affect the rest of 2019 and, you know, are there other tailwinds in the margins that whether it's lumber, labor, or production synergies you could quantify?

Well, I'll start out with the backlog and Diane's guidance with regard to Q2. Q are the sales that we generated in the first quarter and some of the sales that we generated in the fourth quarter that will close in our second quarter. affected by some of the incentives that we use to move our inventory as we said we were focused on a production model and Really geared towards net operating margins, but some of those sales will have a higher incentive in them and as a result have a lower gross margin as we look through the year and We're optimistic that we'll be able to get to a point where we have to offer less incentives to keep that production pace up. You know, we're just beginning the heart of the sales season now, and we'll have to see how the year goes.

All right. Thank you very much.

Our next question comes from Steven Kim from Evercore ISI. Your line is now open.

Yeah, thanks a lot, guys. Good job in a tough environment. I wanted to ask you, Stuart, about your overall comment about the industry taking a natural pause last year. I mean, I just want to make sure that when we get your perspective clearly, now that last year is sort of in the record books and we've sort of gotten back to a little bit of a normalized environment, because obviously rates are continuing to be a little bit jumpy. So when we look at the the decline in demand that occurred last year in the back half, really beginning in the middle of the year. I think you're characterizing it now as the industry taking a natural pause. But you didn't specifically call out the mortgage rate sort of moving north of 4.5%. But I think a lot of people are sort of keyed in on that because a 4.5% mortgage rate was a little lower than I think most people thought would be the threshold above which demand would take a pause. And so as we go forward here with last year in the record books, do you believe that 4.5% represents an important threshold, or do you believe that because we've now had another year of economic growth that maybe a threshold that might be in mind, which should be like a 5% mortgage rate, just want to get your sense of the interplay of the mortgage rate in your generalized outlook for what happened last year, sorry, your reflection on what happened last year, and what you think will happen as we go forward over the next couple of years.

So let me go back to my comments, Steve, and highlight that, you know, I've been, both last quarter and this quarter, I've talked about this natural pause in terms of two components. An accelerated rate of increase in ASP, which we had seen for a number of quarters, together with a very rapid increase in interest rates. And the reason I articulated it last quarter and even in the third quarter as the beginnings of a natural pause at that time is the rate at which sales prices had been moving up was outside of a normal rate. And when you layered on top of that a very quick kind of sticker shock approach to, interest rates moving up. It just created a mismatch between buyers' needs and buyers' expectations. And I felt that it was a natural sticker shock that came from the rapidity at which rates and ASP were moving. So when I think about things today, we've seen moderation on both fronts, as I articulated, both On the price appreciation, we have seen price appreciation, you know, certainly slow down. I said, I used the word stall and even pull back in my comments. And we have seen that. In various markets, we've seen price appreciation really pull back quite a bit in response to demand subsiding. But additionally, layering on top of that, we've seen a discernible, a serious reduction in interest rates. And the combination of the two has really brought the market back kind of into what I think of as equilibrium. The economy has continued to be fairly strong. Unemployment has been low. We've seen wages increasing. We've seen participation rate increasing. And that reflects itself in more dual income families. And so these are the things that we're seeing at our welcome home centers as people come to visit with us that, you know, interest rates together with average sales price, together with the general economy moving in the right direction has really set a stage of stability right now in terms of the market moving forward. Now, against that backdrop, remember that, you know, home production, the production deficit that I keep referencing, we still haven't seen home production get to what most people still think is a normalized million and a half homes per year. We've been decidedly well below that number for a very long period of time. And so we still have a housing shortage. People need a place to live. Affordability has been tested. That affordability test has been pulled back. And so we kind of look forward and think that the market looks pretty good. As to your question about that 4.5% rate is at some kind of an inflection point. I think it has more to do with the rapidity at which rate, interest rate moves together with average sales price alongside of an improving economy. And I think that what we saw in the third and fourth quarter was it just happened too quickly and created sticker shock.

Yeah, and Steve, just one other point on that. As we said in Q4, we didn't see a qualification issue with regard to people when they locked in at the home they could afford. And it was just really a mismatch between buyer expectations and what product they could buy. And now that has been reset, and it's sort of like rebooting a computer, and that's why, you know, Stuart's gotten to the point where, you know, that pause is over and we're back in action again.

Got it. That's very helpful. Talking about the rapidity with which ASPs are increasing, obviously you've got a mix shift that's been going on as you've been targeting more affordable price points and all that, which has been absolutely the right move. But one of the things that we've heard is that the ASP at the entry level is, in many cases, has been over the last couple of years growing at two to even three times the rate of the market overall. And so that's sort of hidden there in this sort of, you know, ASP mix, blended mix. And so I was curious as to when you talk about ASPs, it seems like you're envisioning an environment where ASP growth is going to be a little bit more moderate, a little bit more sustained at a sustainable level. Did you, when you're talking about that, are you talking about a slowdown in the pace of ASP growth at the entry level as well? And then at the back half of that question, you talked about the FHA. Okay. My question on the FHA is, were you surprised at the timing of the move? Were you surprised that they made that move the way they did when they did, or did you expect that?

Well, let me start with the ASB question. And, by the way, we're noting that you squeezed two questions into one. So there's a shoehorn. You know, As it relates to ASP, ASPs have been moving up in part because short supply and in part because the cost structure has been moving up, and we've seen that even more at the lower end. It's very difficult to produce affordable housing at lower prices given land costs and production costs. But there's been a pause in ASP at all price points. that was generated by both interest rates and an accelerated increase in price. And I think that this is exactly why you've seen us shift and focus so dramatically to size and scale in local markets, using size and scale to recalibrate both our building partner program, our builder of choice program, to moderate the acceleration of construction costs and as well our laser focus on technology and recalibrating our SG&A because we recognize that affordability is going to be tested if prices keep getting driven up by the cost structure, and we've got to do some things to offset that. And we've been working really hard at that. So I think you're seeing that prices are going to have some caps to them defined by affordability. And the challenge for the building community is going to be the rationalized cost, both at the SG&A level and the cost structure level, to accommodate what is likely to be slower price increases. And you've seen that yesterday in Kay Schiller. The acceleration of price increases is lower, and I think that that's a little bit behind the curve. You're still going to see that come down. I think that's going to be more the wave of the future. And as it relates to FHA, I'm going to let Rick go ahead and hit that.

We weren't particularly surprised with the timing or the announcement. This has been something that's been rumbling for a while. And, you know, but as I said, the net impact to us is de minimis. Yep.

Thanks very much, guys.

Our next question comes from Michael from RBC Capital Markets. Your line is now open.

Morning. Actually, Mike Eisen on for Mike Dahl. Just wanted to follow up on some of those comments that you guys have made a few times now about pricing resets or more moderating pricing environment. And I was hoping you could talk to for Lenar products specifically, what you guys are doing from a strategy standpoint, whether it being taking down base prices, whether it be smaller square footage and how you guys are addressing this and then how it where, you know, specific regions, you're seeing the most success with this strategy.

John, you want to start off?

Sure. For the most part, this is a very market-by-market approach, in our case, with its product. So we will have some markets where we have taken square footage down, San Antonio, Texas, as an example. And we'll have other markets where the land basis really doesn't allow for that to happen. So on the other end of the extreme, in Orange County, California, where square footage hasn't reduced in price points or made it a higher overall level. Our big focus, as you've heard from all three of us, has been on how do we really moderate our cost structure so that at whatever price we're trying to target, whether it's entry level, first time move up, second time move up buyer, we can be priced affordably in the marketplace against the competition, against the resale market, as a value to that consumer. It's a laser focus on efficient production program to really keep the price points down, recognizing that affordability at each price point is an issue, and we've got to be very responsive to that.

Yeah, and so just to get to the second portion of your question with regard to product adjustments, we are very laser focused on what features we should include in our Everything's Included products to capture the best value and provide the best margin for us and provide the best value for our customers. So we look at footprints. We look at included features. We make adjustments. We have regional opportunities going on right now. So we're very focused on that. From a footprint basis in parts of Texas and some of the Carolinas, you'll see that we're starting to deliver a little bit smaller home. And if you look at just general pricing, you know, on our sales for the last quarter, we were flat year over year with regard to ASP. Some of that is mixed, but some of that is just lower prices on a year over year basis. Our backlog year over year is down about average price and backlog is down about 6%. So that gives you a true look at some of the pricing adjustments that we've made, but that, as John and Diane said, shouldn't really impact our margin going forward.

Just to follow up on the point that Rick made, everything's included platform really allows us to deliver a better value to the customer because they're getting more included features without having to pay extra for it. A good example of that, I was just chatting this morning with our folks in Indianapolis through their regional president, and there they've gone from a complete South Atlantic division, minority-owned presence there, to converting their product to everything that's included. And what they're finding is with the offering, the value offering of everything that's included, their sales pace is picking up in the same communities for the same product. So that product now offered at a lower price. more value features included, and no options available to the customer. So that allows us to also address the issue of affordability.

Got it. I appreciate all the comments. They're very helpful. And then just following up, taking some of those comments and applying them to the impact on gross margins down the road, it seems that there's a few different buckets between synergies, cost savings, lower lumber that are working in your favor, offset by lower pricing. and just a desire to be higher velocity. So can you help us think longer term as you guys are operating this higher volume business model, how we could think about margins moving back higher to some of the higher levels we've seen over the last few years, or is this 20.5% to 21% is a new normal for what the company can do? Thanks and good luck.

Well, maybe I'll take a crack at it. You know, I think we're one of the only companies right now, the only company that's given full-year guidance, and we'd really not like to get over our skis and get into, you know, years outside of the current fiscal year.

So, but let me add to that and say, with that said, while we are taking a conservative look forward as we look at the rest of this year, recognizing that we're coming out of a choppy market, We'll wait and see exactly how the spring selling season shapes up. We haven't just taken pricing as it's come. Remember that we have spent a lot of time focusing on our cost structure using the tools that we've acquired through size and scale and through various technologies to really recalibrate our cost structure and to recalibrate our SG&A. while the progress is incremental, sometimes a little bit slower than we'd like, it is always with regard to our focus on the net margin that we see that we're driving all of our internal strategies. So when you listen to John talk about the cost structure and builder of choice initiatives and things like that, these are all focused on generating a higher gross margin. When you hear me talk about our building a better mousetrap and generating lower SG&A and recalibrating our internal mechanism and our customer interface, it's all about generating a lower or a higher net margin, lower SG&A. So while we recognize that the market might be choppy, might be a little up, might be a little bit down, and as we think ahead, We know some of these initiatives will produce results. They might be slower than expected, and we can't predict them exactly, but we're focused on both the cost side of the business as well as what the pricing might be. Next question.

Our next question comes from Ellen Retner from Zillman Associates. Your line is now open.

Hey guys, good morning. Nice quarter and thanks for all the color here. Great to hear about the improvement in the market. First question on the 2Q guide, if I heard it correctly on the orders, I just want to dig in a little bit more. It seems like you expect orders to still be down a little bit year over year, which given the momentum you saw through the quarter and flipping to positive in February would seem a little bit surprising. So Can you just talk a little bit more about what's going into that? Is that a function of the weather delays you experienced? And kind of how do you see that playing out?

John, let me start off. Some of it is just a function of we've got a bunch of communities closing out this quarter. And we have communities that will get back on track, but it's really late in the quarter. So you're seeing a reflection of you know, the number of sales opportunities we have for community count. And, John, I'll put it to you now.

Just adding on to that, I was going to make that same point. I don't know if you look at it. For us, projected sales pace for Q2 of 19 is actually right on top of the sales pace that we had in Q2 of 18. So it's just community count that's driving the result that you're highlighting. But we feel – very good about how we're positioned given that we're projecting a sales pace over the last year.

So then just to hit the year end or the full year target then, you know, it would seem like a pretty healthy ramp in the back half of the year. Can you just talk a little bit about what your starts growth looks like to support that level of growth?

We have a natural, you know, increase as we move through the year. We are, as I mentioned and we've all mentioned, trying to level it out throughout the year, but we still have an increase in starts as we move from first quarter to second and to third. So our second and third quarter are our largest for starts, and our third and fourth will still be our largest for deliveries. But even this year, that's beginning to moderate as compared to prior years.

Got it. Okay. If I could just add a second one, separate topics. The iBuyer, your Opendoor investment, curious, maybe, Stuart, if you can give us an update on how that's been progressing. How many markets is that kind of being active in right now, and what percentage of your orders is the buyer actually utilizing that on their resale?

So, first of all, we're really enthusiastic about our program with Opendoor. First of all, Opendoor has a just tremendous management team that has a very aggressive agenda, rolling out, not only rolling out to new markets, but more importantly, refining their business model, focusing on both their customer interface and their unit economics. And this is a team that is, you know, just best in class. John Jaffe has the privilege of serving on the board there. And what we have is, and I'll let John talk a little bit more about it in a second, but what we have is a rollout program where as Opendoor enters each new market, we have a side-by-side launch with them of an Opendoor program within our division. And what we have done is we've really mapped out a change management adoption program to include the Open Door tool in our toolbox, whereas we have customers that come to visit us and say, gee, I love your offering, but I have a home to sell. We can turn to them and say, we have a solution. And that mechanism for rethinking the way that customers we work with our customers and taking the friction out of the trade-off and the move-up programs that we have in our system is really working well. Opendoor on its own, in its own world, is doing quite well, but in coordination with Lenar, we're finding greater and greater and accelerated adoption of the program as we go market by market. I have to admit I have lost track of exactly how many markets they are in together with us right now, but we are monitoring market by market, month by month, how many Opendoor-enabled sales we are achieving, and we're really enthusiastic about the program. John?

Well, just yesterday we opened our 18th market with Opendoor in Austin, Texas. And as Stuart noted, it's been a great learning process as we have jointly with Opendoor presented to our operating division, to our sales team, the Opendoor platform. Our divisions eagerly await the opening of that in their market, and we're finding lessons learned and being processed to where each opening execution is better and better than the prior ones. We have some of our first divisions has reached an activity level of 20 transactions a month. That's in Phoenix. And we're seeing, as I said, just better and better execution. So we're very excited about that. We view it as incremental buyers. It reduces our cancellation rate, as it's a solution for our buyers that have a home to sell. And it also helps lower our brokerage spend as that buyer – Very often we reach earlier in the process, and they don't have a broker yet, so they're not involved in the equation. So all in all, we're extremely enthusiastic about the program. We've got a great working relationship with the management team there. We work hand-in-hand to learn from each other. We learn technology from them. They learn operations and real estate from us, and we're both improving from that.

Let me add one more point here since you've opened the door on open door. Maybe the most important thing that we are learning and this is where we are working around the clock is we're learning about change management. Change management from the way things have worked and worked quite well to a progressively better way to interact with our customer and pull friction out of our programs and migrate our associates to understand that there is a better way to transact. And that change management process has friction points of its own. We are learning as we are doing, and we are evolving our ability to communicate internally. And that, to me, is perhaps one of the most exciting parts of the program. We're going to get better and better at this, not just with Open Door, but with Blend, with States Title, and with others that we're engaged with, with HIPPO. Our technology initiatives are, we have a great deal of enthusiasm for them, but our ability to integrate them and work with them is getting better and better all the time. Thanks a lot. Last question.

Our last question comes from Michael Rehout from JP Morgan. Your line is now open.

Thanks. I guess right now it's good afternoon, everyone. Thanks for squeezing me in. I have just one question in 27 parts. Just kidding, obviously. First question just on incentives. I was hoping to get a better sense. You talked about the market being choppy throughout the quarter, but at the same time improving as mortgage rates perhaps and the spring selling season progressed. I was wondering how that related to incentives as they progressed throughout the quarter, and in particular, what you saw across parts of California.

Well, throughout the quarter, as I said, we continue to incentivize in order to move our completed product. This is something we're going to continue to do in each period as we price our inventory to market using our dynamic pricing model. We believe that as we move into Q2 and to Q3, at the level of incentives is going to start to dissipate. And we've started to see that through conversations that we've had with homeowners as we move through the quarter.

And with respect to California, Michael, we definitely consistent with what I said earlier in the more affordable market, Central Valley, Sacramento, the incentives are proportionately lower than they are in the coastal markets. And in all those markets, the central markets, we did see lessening incentives towards the end of the first quarter. And the coastal markets, it's just as Rick is saying, that we use those incentives to generate the sales pace improvement in those markets.

Okay. Thank you for that. I guess, secondly, just shifting gears a little bit to return on equity. You've obviously highlighted some of the initiatives that you're doing in terms of returning to your core business, selling off some different businesses, as you highlighted, with different parts of the brokerage and title, et cetera. How do you see, over the next two or three years, where do you want to be in terms of total asset sales or as it relates to kind of slimming down your balance sheet, let's say, as well as share repurchase. Because when you look at ROE, and that has had a pretty powerful relationship between that metric and valuation multiples, and with your ROE being below some of your larger cap peers, you know, where do you want to see that metric go? And, you know, what are you willing to do in terms of, again, additional asset sales or, you know, more aggressive share repurchase, for instance, to get there?

So, you know, we're very focused on return on equity. And let me just say, I think we're going to try to get one more question in before we end the call. But I think that a combination of generating strong earnings and that strong earnings power coming from, in part, what we're doing relative to our SG&A is going to be a primary driver of stronger ROE. As we have an opportunity to continue to pare down ancillary businesses, as we've said, we're going to do that, but we're not going to force the issue We think that there are intrinsic values to the assets that we have, whether it's LMC, our multifamily program, or whether it's Five Point. So we're not going to force the issue, as we haven't and didn't with Rialto, but we're going to migrate to a core business strategy where that's where our focus is going to be, and we're certainly going to be focused on using technologies, both internal initiatives and external, to increase bottom line. Let's go to one more question. Operator?

Yes, we still have a few questions in the queue.

Let's take one more.

Thank you. Our next question comes from Steven East from Wells Fargo. Your line is now open.

Thank you. Thank you for squeezing me in there, Stuart. You know, first, you've got this big combined company. You all have talked, you know, now about the developer agreements and starting to get them off the ground some. Could you talk about maybe, you know, first of all, what geographies are you in, if you're willing to talk about that yet? And then as you look at your ability to option more land at a faster pace, maybe, Or can you all talk a little bit about where you are with that process and how fast you think you can accelerate your optioning of land off that?

Well, it's Rick, Steven. You know, as I mentioned last quarter, the deals that we brought into place, the three deals, catapulted us to about a 30% control position. And we expect that over the next 18 months we'll be north of 40 based on the arrangements that we've got in place. You know, this is a program, you know, sort of getting back to that last question, what's the biggest mover with regard to where we can enhance our return on equity? It's moving to an asset-like program that Stuart really identified our pivot going back two or three years ago. So we're going to continue this on. You'll see a higher concentration of deliveries coming from vehicles like this. And as I said last quarter, given the type of arrangement that we have and our right to purchase from these things without a contract, you may not necessarily see them directly in our controlled own count because of the way that they're structured. Sure, sure. And as far as other markets, we've expanded them to other parts of the southeast. Let's just leave it there. All right. Fair enough.

Fair enough. And then on your community growth, you know, a more immediate question than a bigger picture question, when will you turn positive, you think, in your community growth this year? And then as you think about your business in a broader sense, How fast would you all be satisfied growing your communities and really your unit growth, if you will? Just a big picture question.

Yeah, so really by the time we get into Q3, first month of Q3, you'll start to see a flat year-over-year community count. You know, we had a double whammy come in this last quarter. We had a bunch of communities closing out. where, you know, just because we had good programs going on with regard to sales activity, and we had about 30 communities that were delayed because of weather to get us going. So we'll start to see a more normalized year-over-year comparison as we get into Q3. And, you know, as we've said, we plan to grow community count as we move forward in the market.

From a bigger picture, you know, where would you be comfortable and how do you think about your unit growth, you know, over time?

You know, as we said in the past, we think that we want to grow our business about three, you know, a minimum of three to five to seven percent with regard to, you know, unit activity. Some of that... will be associated with a little bit higher absorptions as the market recovers on a community-by-community basis, but some of it is going to be tied to incremental community growth. But really our zip code is 5% to 7% for the next year, year or two. Okay. Thanks a lot. I appreciate that.

Okay, we're going to wrap it up there. I want to say that I appreciate everybody joining and let me just circle back to where we started and that is we highlighted that we felt that the home building market had entered a pause in the third and fourth quarter. We found evidence of stabilization in the first as we migrated through our first quarter. We look forward to checking back and giving an update on how we're going from here. But with that said, we are optimistic that the housing market has found firm ground and is ready to move forward. Thank you for joining. We'll speak to you next quarter.

That concludes today's conference. Thank you for your participation. You may now disconnect.