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Lennar Corporation (NYSE:LEN)

Q3 2008 Earnings Call

September 23, 2008 11:00 am ET

Executives

Scott Shipley – Director IR

Stuart Miller – President & CEO

Bruce Gross – VP & CFO

Diane Bessette – VP & Treasurer

David Collins - Controller

Analysts

Dennis McGill – Zelman & Associates

Carl Reichardt – Wachovia Securities

[Susan Berliner] – JP Morgan

David Goldberg - UBS

Tim Jones – Wasserman and Associates

Stephen Kim – Alpine Woods

Michael Rehaut – JP Morgan

Josh Levin – Citigroup

Chris Hussey – Goldman Sachs

Nishu Sood – Deutsche Bank

Megan McGrath – [Barclay’s Capital]

Jay McCanless – FTN Midwest Research

Operator

Welcome to Lennar’s third quarter earning conference call. (Operator Instructions) I will now turn the call over to Scott Shipley, Direct of Investor Relations for the reading of the forward-looking statement.

Scott Shipley

Good morning. Today’s conference call may include forward-looking statements that are subject to risks and uncertainties relating to Lennar’s future business and financial performance. These forward-looking statements may include statements regarding Lennar’s business, financial condition, results of operations, cash flows, strategies and prospects.

Forward-looking statements represent only Lennar’s estimates on the date of this conference call and are not intended to give any assurance as to the actual future results.

Because forward-looking statements relate to matters that have not yet occurred, these statements are inherently subject to risks and uncertainties. Many factors could cause Lennar’s actual activities or results to differ materially from the activities and results anticipated in forward-looking statements.

These factors include those described under the caption Risk Factors contained in Lennar’s Annual Report on Form 10-K for its most recently completed fiscal year which is on file with the SEC.

Please note that Lennar assumes no obligation to update any forward-looking statements.

Operator

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

Stuart Miller

Thank you and good morning everyone. Thank you for joining us for our third quarter 2008 update. I am joined this morning by Bruce Gross, our Chief Financial Officer; Diane Bessette, our Vice President and Treasurer and David Collins, our Controller.

Bruce will provide additional detail on our numbers; David will give you an update on our asset review and impairments, a report have given for over two years now and Diane will be available to participate in our question-and-answer period.

Just as a housekeeping item before I start I would like to request as always, in our question-and-answer period that will follow our opening remarks that you please limit to just one question and one follow-up so that we can be as fair as possible to all of our participants. Of course we welcome you to rejoin the queue if you have additional questions and we will attempt to answer as many questions as possible.

Now in the context of what has been perhaps once of the most difficult quarters in homebuilding history, Lennar’s management team and associates have put forth an extremely productive quarter. We have continued to focus on the basics of rebuilding our operating business while we’ve also continued to carefully manage our asset base and work diligently to rework and reposition our joint ventures.

We feel that we’re making credible progress towards profitability in the most difficult of times. In the third quarter the housing market continued to deteriorate though at an accelerated rate. June and July were truly dismal sales months and in August we saw what I would call a phantom uptick, which derived primarily from the pending elimination of the down payment assistance program on October 1st of this year which was part of the so-called stimulus package passed in July.

I’m asked regularly as to whether or not we’re at the bottom and I feel overall that we’re not there yet. In this market we recognize that some things are just out of our control and we’re simply not going to be able to alter those elements. The items that we can control however, we’ve been all over them in each of our divisions.

Just over two weeks ago, our senior management team visited with each of our divisions as we did our operations review. A review of our reported numbers showed the meaningful progress that we found in each of our divisions. We’re rebuilding our gross margin which showed improvement of some 400 basis points year-over-year before valuation adjustments to 18%.

Our operating margin before valuation adjustments has improved some 230 basis points to 2.3% producing a diminished loss from operations for the quarter of just under $7 million. While a portion of this improvement no doubt derives from impairments previously taken and Bruce will cover that later, an increasing proportion stems from a focused re-engineering of our product, materially reduced construction costs and a determined attention to right-sizing our SG&A which stands at a still-disappointing 15.7% of lower then expected revenues.

Nevertheless, our SG&A is down some $148 million or 49% year-over-year and we expect continued meaningful improvement in SG&A in the fourth quarter in both dollars and percentage.

We’re starting to see a quarterly progression of positive trends in this distressed market environment which positions the company well for rebound in the future. A few basic highlights show that gross margin has improved from 15.9% in the second quarter to 18% this quarter.

Operating margin has improved from 0.5% in the second quarter to 2.3% this quarter and pre-tax loss before valuation adjustments has declined from almost $36 million in the second quarter to just under $7 million this quarter.

Impairments are also declining though modestly, from approximately $137 million in the second quarter to approximately $132 million in the third.

Generally speaking there are not yet signs of stabilization in the field, demand patterns are inconsistent and erratic, and we have found that there’s an increasing flow of foreclosures that are maintaining downward pressure on prices and appraisals.

In most markets it’s apparent that the flow of foreclosed homes is expanding rather then subsiding. There is a silver lining in all of this though it is currently of limited consequence. The positive news from the field relative to some markets is that inventory of finished new homes is coming down and the number of competing new home communities is declining and the number of builders is also declining.

With market conditions still extremely soft though, our operating progress is meaningful. On the asset management front, we’ve continued to fortify our company by continuing to manage and restate our land assets, while we simultaneously keep our inventory of completed homes very low and reduce the number and composition of our joint ventures.

In fact, we have reduced the number of joint ventures from 270 at the peak, to 146 currently and that’s down from 163 last quarter. Of those 146 joint ventures, 67 of them have no debt, 31 have non-recourse debt, and 48 have recourse debt.

Recourse debt to joint ventures is down from a high of $1.8 billion in 2006 now to $630 million which is down some $177 million from last quarter. We have reworked, or are close to a rework on most of our non-performing joint ventures and the trend on joint ventures is positive. And we will not and cannot comment on specific ventures, we have held true to our conviction that we do not support the debt the non-recourse obligations and we are not excusing partners from sharing partnership losses.

And while the renegotiation process can be difficult and time consuming, many of our partnerships have presented us with an opportunity to actually enhance our investment position. Our overall land asset is down similarly. Additionally each division brought tremendous focus on inventory homes in the third quarter and reduced completed inventory by almost 50% year-over-year.

Great progress has been made on the asset side of our business so management can focus on sales, construction and SG&A and our divisions are in fact focused on the basics of blocking and tackling [and] fewer home building.

On the corporate side we’ve complimented the progress in the field. Our balance sheet remains strong with a substantial cash position of $857 million. While that is down slightly from the second quarter we continue to seize opportunity where distress creates unique value, rather then walk away from opportunity.

We anticipate that we will continue to use available cash to harvest value and opportunity from our joint ventures as they arise. Additionally there is nothing borrowed on our revolver and we have a responsible debt-to-total capital position at 40.5% and net of cash that is just over 30%.

In the wake of the meaningful restatements of assets that we have undergone and the repositioning of many of our venture properties, this is meaningful progress. And while we continued to lose money in the third quarter with a loss per share of $0.56, and a homebuilding operating loss of approximately $92 million, aggregate levels of impairments and losses are more in the nature of clean-up rather then reconciliation to unknown market conditions.

As I have said in prior quarters, we have done the heavy lifting on impairments and we are not situated with stated assets that can and will produce improving margins when the rate of decline in market pricing subsides.

We are confident that even with continued degradation of market conditions; our stated asset base will not require significant downward correction.

In conclusion let me say that we’ve made a great deal of progress in a very difficult market. We’ve prepared our company for market conditions as they currently exist and we are not projecting a material improvement for some time to come.

But as I’ve said before, this should not be confused with abject pessimism. In fact, I remain quite optimistic about our business and the housing market in general. Although it is difficult to find reason to be optimistic in these unprecedented turbulent market conditions, I believe this market will rebound.

It will have to rebound in order to stimulate the rest of the economy back onto its feet. Whether over the next month or after the election, steps will be taken out of necessity to facilitate home ownerships leadership out of the economic doldrums.

We have finally come to a time when consensus is building that falling home prices are not only detrimental to the economy at large, but in order to repair our failing financial system we will have to stop the decline.

Sooner or later, Washington will connect the dots that indicate that a floor in home prices will provide the foundation on which we can actually build a future. The current stop-gap measures to aid hard-hit financial companies will be repeatedly frustrated by falling home prices and the securities that back them.

Any meaningful solution to the credit crisis will necessitate a simultaneous stabilization of the housing market. The housing stimulus Bill that was passed by Congress in July simply was not enough. In fact, I would argue that the Bill was net net, anti-stimulative.

The $7,500 tax credit which was actually an interest free loan, created very little incentive to families looking to purchase a home and the elimination of the down payment assistance program and the increase in the FHA down payment requirement from 3% to 3.5%, actually took purchasers out of the market when we could least afford it.

The indicators keep coming in and its seems that we are quickly approaching the time where decision makers will reconcile to the reality that positive constructive steps need to be taken to properly support weakened markets and enable them to recover.

If we’re going to get homeownership back on its feet, and stop the fall of home prices, we’re going to need to facilitate the absorption of inventory by encouraging buyers to start purchasing again and we’re going to have to facilitate a mortgage market to be able to lend at multiple price points to those purchasers.

This fix continues to be the bright light that I see at the end of homebuilding’s dark tunnel. And while we might argue or suggest that actions are late, it does seem that there is a floor out there where enough negative news which is now confirmed, will result in enough action to bring on sustainable stabilization.

The housing market is faced with increased supply from foreclosures and suppressed demand. Home inventories primarily existing homes, are expanding and will have to be absorbed before pressure is relieved from sales volume and pace.

At Lennar we’ve been heads-up throughout the downturn in the housing market and we’ve prepared our company to succeed in current market conditions and to thrive when the market ultimately corrects.

Thank you and I’ll turn it over to Bruce now.

Bruce Gross

Thank you Stuart and good morning. As Stuart discussed, this is a quarter of significant progress and I’ll be providing some of the financial details supporting that progress.

Turning to the operating results for the quarter, we have narrowed our pre-impairment loss to $0.03 per share for the quarter. David will walk us through this quarter’s impairments which as you will see, these impairments are largely behind us at this point.

Revenues from home sales decreased 54% to $996 million driven by a 49% decrease in home deliveries and a 9% decrease in average sales price to $270,000.

The average sales prices net of sales incentives, which averaged $45,900 per home during the quarter and that was flat with the prior year’s number. The average sales price declined regionally as follows: the East was down 7% to $263,000, Central was down 3% to $200,000, the West was down 15% to $376,000, and the Other category was flat at about $300,000.

We continued to improve on the positive trend in operating margins. Our gross margin was 18% before impairments and our selling, general and administrative expenses were 15.7% resulting in the 2.3% operating margin Stuart mentioned.

The pre-impairment gross margin improved 400 basis points over the prior year and this improvement in gross margin was due to first, a lower land base from the exhaustive asset reviews each quarter, impairing assets to be reflective of today’s market conditions, as well as, more recent land purchases which are reflective of current market conditions.

And then second from lower construction costs. We have aggressively reduced the number of floor plans in our markets, rebid our construction plans and we have centralized purchasing to achieve savings on both the local, regional and national scale.

Our construction costs per square foot have been reduced by close to 15% from the peak. The operating strategies to achieve these cost savings have taken some time to be implemented and recognized in the numbers and we are now seeing the results in our numbers.

The East region experienced the largest improvement in the gross margin during the quarter. Similarly, the operating measures taken relative to right-sizing SG&A have taken some time to be implemented and recognized in the numbers. SG&A expenses were reduced by $148 million or 49% versus last year and as a percentage of revenue was up 170 basis points to 15.7%.

During the quarter we expensed approximately $15 million of non-recurring severance and lease termination costs as a result of additional division consolidations. We have made significant progress in reducing SG&A costs however our volume has fallen at a faster pace.

As a result of these additional division consolidations, we have now reduced both our divisions and our headcount by approximately two-thirds since our peak in 2006. These measures taken should enable us to see significant reductions in our SG&A percent going forward.

New order were down 42% during the quarter compared to the prior year. The number of homes in backlog declined 44% year-over-year and our cancellation rate declined to 27% for the quarter from 32% in the prior year’s quarter.

We have seen significant progress from our financial services operations as well as profits improved from a loss of $5.2 million to a profit of $12.8 million and all of these financial service numbers I’ll be discussing are excluding a $27 million write-off of all the goodwill in our mortgage subsidiary in the current quarter.

Mortgage-free tax increased from a loss of $2.3 million to a profit of $14 million. This quarter our mortgage capture rate improved from 72% in the prior year’s quarter to 87% in the current quarter. Almost all of our loans in this quarter were fixed rate loans and the percentage of government loans increased to about two-thirds of our mortgage originations in the current quarter from 25% in the prior year’s quarter.

Our title company narrowed their loss to $600,000 for the quarter compared with a $1.3 million loss in the prior year and [title] has made significant progress in right-sizing its operations to today’s market conditions and actually showed a profit in August, which was their first monthly profit since June of last year.

We continued to focus on a strong balance sheet as we aggressively reduced our JV recourse indebtedness while maintaining our strong cash position. We generated EBIT during the quarter before valuation adjustments of $21 million which is an increase from the second quarter and then as Stuart mentioned we had $857 million of homebuilding cash on the balance sheet while we had zero outstandings on our revolving credit facility.

As our liquidity position remains strong and our leverage on a net debt to total capital basis actually improved from the third quarter of the prior year down to 30.2% we also had substantial equity with $3.4 billion at the end of the third quarter.

We have made significant progress on the reduction in the number of unconsolidated JVs and a reduction of recourse indebtedness, as Stuart mentioned while we maintained strong liquidity and a strong cash position.

I won’t repeat all the numbers that Stuart mentioned but I will highlight again that the maximum recourse JV indebtedness has come down from approximately $1.8 billion at the end of 2006 to $630 million at the end of this quarter and our net recourse JV exposure has been reduced to $492 million at the end of this quarter. That is net of reimbursement agreements we have with our partners.

This quarter’s progress was significant as we are approximately three quarters ahead of schedule with respect to our bank covenant on maximum JV recourse reduction and we have accomplished the reduction again with the minimal change in our cash balance.

The total cash payments relating to re-margining guarantees with JVs having recourse debt during the quarter was only $9 million and there was also significant progress made during the quarter in reducing our financial letters of credit which are down about 60% from the peak which was $728 million at the end of 2006, to $294 million at the end of this quarter.

We have continued to carefully manage our inventory levels as they have been reduced by 36% from the prior year’s quarter to $4.1 billion and that excludes consolidated inventory not owned. Finished homes and construction in progress was reduced 29% from $3.2 billion to $2.2 billion year-over-year. Land under development was also reduced 42% from $3.2 billion to $1.8 billion year-over-year and from the second quarter of this year inventory increased sequentially about $200 million, but that was all due to strategic purchase of assets from joint ventures as a result of renegotiations with our partners.

Inventory purchases declined 60% from last year’s third quarter from $348 million to about $139 million and that was also a sequential decline from our second quarter which had land purchases of $162 million.

We have reduced our unsold completed homes by about 50% from the prior year to 623 at the end of this quarter, which averages just over one per community. We have continued to manage starts to today’s demand levels and as a result, homes under construction have declined over the prior year by 31% from 9,100 to 6,300 in the third quarter.

And our home sites owned and controlled have been reduced by 62% since the peak in 2006 from about 346,000 to 130,000 today and that’s comprised of 7,600 owned, 15,000 controlled by options with third party sellers and 39,000 options from joint ventures.

Again we have made significant progress this quarter and we look forward to discussing additional progress when we talk with you again next quarter. And with that I’m going to turn it over to David to discuss an update on impairments.

David Collins

Thank you Bruce and good morning everyone. As is tradition during our conference calls, we are once again providing an update of our impairment process to provide further clarity.

In this morning’s release we outlined our third quarter valuation adjustments of $132 million. We continue to remain actively engaged in our rigorous process of division by division asset reviews to ensure that our assets are properly stated.

We started this impairment process almost three years ago and were diligent early on in reviewing our asset base and recording impairments. As we have previously disclosed we believe that most of the heavy lifting regarding impairments is behind us and that we are at the tail-end of the impairment cycle.

Let me quickly summarize our third quarter impairments. First the Homebuilding side of our business, we applied the standards of FAS B 144 to land that we intend to build homes on and recorded a valuation adjustment of $32 million. This amount was 56% lower then the homebuilding impairment charge we recorded in the second quarter of 2008.

The segment detail is as follows: East segment was $9 million; Central segment was $3 million; West segment was $19 million; and Other was $2 million.

The second bucket is land that we sold or intend to sell to third parties. Consistent with our strategy of converting inventory into cash, we identified land that we sold during the third quarter or intend to sell subsequent to the third quarter. We applied the standards the FAS B 144 to that land and recorded a valuation adjustment of $13 million.

The segment detail is as follows: East was $11 million; Central was $1 million; and the West was $1 million.

Third, we have the next category which relates to land and adoption deposits and pre-acquisition costs. We continue to evaluate, reevaluate and renegotiate deposits on land under option as markets remain challenged. For those option contracts where we were not able to adjust or readjust the terms to a level that would lead to an acceptable return based on current market conditions, we made the decision to walk away from the contract as we have done in past quarters.

As a result we wrote off $11 million of option deposits and pre-acquisition costs which represented approximately 900 home sites. The segment detail is as follows: East $1 million; Central $2 million; West $6 million; and Other $2 million.

As we do with all of our assets we continue to evaluate and reevaluate our investments in joint ventures. In our review we focused on the recoverability of our investment relative to the market conditions that exist today. We applied the standards of FAS 144 to the assets in our joint ventures, including the evaluation of discounted future cash flows.

Additionally we applied the standards of APB 18 to our investment balance relating to those ventures. In the third quarter we recorded a valuation adjustment of $43 million. This amount was 22% lower then the JV impairment charge we recorded in the second quarter of 2008.

The segment detail is as follows: East segment $10 million; West segment $20 million; Other $13 million.

In addition this quarter we recorded $6 million of write-offs of notes receivables due to their uncollectability. The segment detail is as follows: West $1 million; Other $5 million.

Finally we review goodwill for impairment annually or whenever indicators of impairment exist in accordance with FAS 142. As a result of this review our financial services segment recorded a $27 million write-off relating to the goodwill of this segment’s mortgage operations.

So after that overview we’d like to open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Dennis McGill – Zelman & Associates

Dennis McGill – Zelman & Associates

You touched on this in a few different ways, can you offer your opinion on what’s positive and maybe negative about the current talked about bail-out plan and then as it relates to a stimulus what would you think would be most helpful to the market that the government could do that they’re not doing?

Stuart Miller

The bail-out plan I think is still taking shape and I think that any commentary on that is premature. I mean, I think that everybody is looking at it and still trying to figure out exactly what it is. It certainly seems that we’re going to have something akin to an RTC type program, almost a throw-back to the early 90’s and if you look at the mass of assets that are embedded in the financial structures, there’s going to have to be some kind of a movement from private to public and then a repackaging of those assets and distribution back into the private sector like we saw in the early 90’s.

But exactly how they’re going to do this, the financial stress is far more complex this time around then it was in the early 90’s and I think we’re going to have to sit back and watch. As it relates to the housing market, I feel pretty strongly that if they don’t get housing prices to stop falling given the way that the fallen housing prices amplifies through financial structures to the securitizations that are out there and they way that those securitizations impact others, we’re just going to be chasing the market downward and each financial fix will be frustrated.

And I said that in my comments. In terms of what constructive measures can be taken, the homebuilders had really tried to express as the July stimulus Bill went through Congress that the $7,500 interest-free loan was not likely to produce a lot of activity in the market. When that was the result we were hopeful and we tried to support it, but the reality in the marketplace is that the Bill has really been a net negative. Our focus had been to kick-start the housing market and to get people buying again with a real tax credit more in the $15,000 to $20,000 per home range and we felt and continue to feel that its that kind of stimulus for a period of time—maybe its six months, that will be needed to kick-start the market, get people buying and therein support the fall in housing prices with purchase activity.

The positive of that kind of program is that it doesn’t come with the stigma of moral hazard and does a lot to support the housing market. Sure there are other thoughts out there that are equally good; that’s just mine.

Dennis McGill – Zelman & Associates

On the idea of moral hazard, do you think the tax credit is beneficial to the idea of maybe buying foreclosures that are out there which are I assume pressuring, creating a lot of that home price pressure that you’re talking about?

Stuart Miller

I don’t know how to break it down perfectly, even in my own mind; I get a little confused on this. It just seems to me that we’re going to have to get the volume of purchasers up no matter how you cut it, to absorb foreclosures and to get the market buying again, and how its distributed, whether its foreclosures or new homes or whatnot, I just don’t know what that right formula is but it seems to me that anything that we can do to get people buying homes again and recognizing that there’s some fabulous values out there.

If ever there’s a time to buy a home, now is it. Its just a matter of getting people over the hurdle of saying, I want to buy a home, and then getting them positioned with a down payment that they can come up with and a mortgage that is properly positioned and affordable to them.

It seems to me if we get people buying, the mortgages on today’s home prices will be secure, profitable to the lenders and the homes are more likely to go up over time because of the low pricing point that they’re at right now.

Dennis McGill – Zelman & Associates

Do you have the payables number from this quarter?

Bruce Gross

The payables number from this quarter we can follow-up with you.

Operator

Your next question comes from the line of Carl Reichardt – Wachovia Securities

Carl Reichardt – Wachovia Securities

You talked about some phantom demand in August from down payment assistance and kind of pulling that forward, I was wondering if you could quantify that a little bit or talk about how responsive you think consumers were to those promotions and if that does the slight [inaudible] to potentially reverse it, if that does materialize, what that would do for you?

Stuart Miller

We’ve given that a lot of thought and if you look at August there was clearly a spike in the use of the down payment assistance programs and the promotions brought in a lot of buyers. As we dissected the flow of people coming in, we came to realize that a number of the people that ultimately used the down payment assistance program didn’t need the program but they used it because it was a good deal.

We kind of view that the impact of its loss, the loss of the down payment assistance program, is going to be somewhere between 10% and 15% of the buying market right now.

Carl Reichardt – Wachovia Securities

And do you have any thoughts on the potential for it—the elimination of it to get reversed?

Stuart Miller

I think in today’s market just about anything we can think of is on the table and there’s no way to handicap it and I don’t mean for that to sound funny, I think it’s just too tough to call. There’s clearly legislative consideration as to whether it should be—the program should be reinstated.

I think that overall from a policy standpoint we and the industry understand that as a policy matter its probably better not to have down payment then to have it in the long run, but I think that emphatically we believe that right now and today is not the time to cut off the blood supply to the patient that’s on the operating table.

Operator

Your next question comes from the line of [Susan Berliner] – JP Morgan

[Susan Berliner] – JP Morgan

I think you had noted that you think impairments were going to go down pretty materially going forward, I was wondering how that drives with your thoughts on a price decrease going forward?

Stuart Miller

We do believe that our impairments will continue to fall. First of all our asset base is materially smaller then it was a year ago, but additionally we think that as David has said, clearly we’ve done a lot of very heavy lifting in terms of impairing our assets. Some of the impairments that you are seeing are reflective of those continued price decreases that you see in the marketplace and will continue to have what we call this clean-up until prices stop declining. But because of the smaller asset base and because we’ve done so much of the hard work already and brought out asset values down to clear profitability, or the ability to make a profit, our projection is even with prices declining we have a solidly stated asset base.

David Collins

I would just add to that, that as prices have come down we’ve put a lot of attention to redesigning our product and focusing on bringing down construction costs as well as we’re delivering a smaller product and we’re focused on how do we maintain a high margin as the market is in the condition it is, and a lot of that is coming from the progress on construction cost reduction.

[Susan Berliner] – JP Morgan

If you could provide any details on your bank availability or tangible net worth cushion, that would be great.

Bruce Gross

We can say that we’re in compliance with all of our covenants and we believe we have enough cushion with tangible net worth and as you’ve asked the question in the past about borrowing basis, somewhat of a circular formula we have availability under our borrowing base, we have to use cash over $500 million first. Any cash that is used to buy inventory gets added back into the borrowing base so it’s a little bit circular but we are in compliance of all of our covenants as we’ve mentioned to you in the past.

Operator

Your next question comes from the line of David Goldberg - UBS

David Goldberg – UBS

I was wondering, incentives were flat this quarter in the release but you commented pretty in depth and gave us big color on how conditions were getting worse through the quarter and how SG&A as a percent of revenue was higher because or wasn’t the operating leverage maybe that you thought there was going to be, and I guess I’m trying to understand how you’re thinking about profitability versus sales volumes now and maybe with that how it bakes into the impairment analysis in terms of the assumptions as you look forward?

Stuart Miller

As we went into June and July as I noted, the market just really fell off precipitously. We’ve tried to carefully manage a balance between volume and sales price and incentives, but we have decidedly favored not chasing volume and operating leverage in favor of reducing profitability. So we clearly have moved to a direction of saying that, you know what? Let’s decrease our volume. Let’s continue to cut overhead. Let’s continue to renegotiate construction costs, but we’re simply not going to chase volume. There’s no reason to build homes if we can’t do it profitably.

David Goldberg – UBS

With regard to your sale of some of your equity interest and bringing in Hillwood into your JVs, replacing [Eleanor] and in some cases and then buying some of your equity interest, I was wondering if we could get some detail about what kind of cash that generated as selling your equity interest and also a little about how many JVs you’re still involved with with [Eleanor] and maybe just exposure on it and your comment about those deals a little bit?

Stuart Miller

Let me just comment conceptually, first of all the addition of Hillwood is a very positive addition. It was more in the nature of replacing a partner then a cash generator. I think the—it was important in [Hunter’s Point] to be able to bring on a partner that is enthusiastic about the future of that opportunity as Hillwood is and brings to the table some individual expertise as Hillwood does, replacing a partner in [Eleanor] that has similar expertise but has less appetite.

So this was a very good strategic move for the company. In terms of the number of joint ventures that we have with [Eleanor], I think we have about seven and [Eleanor] continues to be a solid partner and financially very strong. So that’s a positive. Might there be other transactions with them, that’s something that’s opened to question. In markets like this you just have to figure that everything is on the table.

Bruce Gross

The cash from the transaction brought in approximately $120 million of cash of which the majority of that about $80 million was used to buyout existing partners.

Operator

Your next question comes from the line of Tim Jones – Wasserman and Associates

Tim Jones – Wasserman and Associates

I think probably the most important thing you said was the 15% reduction in costs per square foot, what period did that relate to where the peak was? And secondly, break it down by either land or reversals of prior write-downs and labor and obviously the effect of changing your construction methods and overall cost of materials if you can or just a guess on it.

Bruce Gross

The peak that we’re comparing to is 2006.

Tim Jones – Wasserman and Associates

What quarter?

Bruce Gross

I don’t have an exact quarter for you, but it was the earlier part of 2006.

Tim Jones – Wasserman and Associates

And how about the breakdowns of that 15%, how they come into various components, what percentage of how much is land, how much is reversals, or how much is materials, how much is redesign?

Stuart Miller

That 15% is all construction costs. I think that would be comparable sticks and bricks. Concurrent with that, we’re saying as an addition to that there was the redesign of homes which brought down square footages or redesign to a more efficient design and then on top of that as an addition and separate item, you would have impairments that are flowing through that are a component of that.

But I think that what we’re trying to highlight though, maybe not affectively highlighting it, is that clearly impairments are contributing to margin improvement but its been to a lesser proportion, and we can’t exactly delineate this, then say two or three quarters ago that the redesign contributed, that the reduction in construction costs contributed and the reduction in SG&A contributed.

Those latter three components are contributing a greater proportion to our margins.

Tim Jones – Wasserman and Associates

So you’re saying that these other factors, you could have another five for each percent and you could actually be down 25% roughly? Say 5% from lower land, 5% from redesigns? Something like that?

Stuart Miller

I guess if I had to give you my impression, I think that there’s less upside to realize from construction costs going forward. It’s a diminishing amount. I think there’s a greater upside to be realized from SG&A which will continue to contribute positively and product design, we’re getting very close to having our product designed across the country so that implementation is already being reflected as well. But all three of those together are really powering a better net margin.

Operator

Your next question comes from the line of Stephen Kim – Alpine Woods

Stephen Kim – Alpine Woods

On your financial services I noticed that if you add back the goodwill impairments there you would have recorded a profit of about $14 million. I wanted to know whether or not that was a good number to sort of think about going forward or if that was a figure that had maybe some one-time things in it?

Bruce Gross

As you take a look at that, let me break it into two pieces. One is [title] is on the track back to profitability so that component is going the right path. And the other component is the mortgage side which I think that’s a pretty good number on a go forward basis. We had one of the highest capture rates we’ve seen in some time at 87% but that’s been our focus and I think that’s probably a good number assuming that the number of government loans that we originate continue to be at these high levels because we make more on a government loan then we do on other loans.

Stephen Kim – Alpine Woods

Relating to SG&A, I know this is a question that we chatted about last quarter, I think at that time you had talked about a 10% SG&A target and was curious as to what your anticipation is or what your thoughts are now about the [realisticness] of obtaining a 10% SG&A target which admittedly would be a very good result for you. Do you still think that’s in the offing here in the next quarter or two or do you think that maybe is not a realistic number?

Stuart Miller

If we think back to last quarter, I was rather emphatic about that number and I guess I have to say today that I feel less emphatic and optimistic about it primarily because of the way that revenues have come down really more then we had expected.

But we are extraordinary focused on exactly that number and we do expect to be down below 10%. That’s going to be easier to have happen as the market starts to return and revenues go up. Are we going to hit it in the fourth quarter? I’m a lot less optimistic about that right now. We’re going to have to wait and see. I will tell you that in going to our operating reviews this is the primary focus within each division and a number of our divisions are actually going to be there.

But I think that overall we might fall a little short of that number.

Operator

Your next question comes from the line of Michael Rehaut – JP Morgan

Michael Rehaut – JP Morgan

On the cash flow generation, it looks like you generated operating cash flow of about almost $800 million through the second quarter, the additional $100 million this quarter, right now what are your expectations for the fourth quarter and looking ahead based on your current expectations for the business and the market and with your backlog down over 40% here, directionally where do you see cash flow generation in 2009 versus 2008?

Bruce Gross

As far as the fourth quarter goes, we don’t have an exact number for you but we can tell you is that we are incredibly focused in continuing the manage our inventory very carefully so we continue to focus on managing inventory both from delivering homes that are available to be delivered as well as reducing our land purchases.

And that’s where the majority of cash flow generation is coming from. Of course it depends a little bit on the market as far as what holds for the fourth quarter as well as going into 2009, however again we’re very well positioned from an inventory perspective as we look forward and again in 2009 we expect to be cash flow positive. We haven’t put out an exact number at this point though.

Michael Rehaut – JP Morgan

So what would you expect land spend to be in 2009 versus 2008 and if you could break that out between new raw land purchases versus development costs?

Stuart Miller

We’re not making any projection. In today’s market we’re not looking forward.

Michael Rehaut – JP Morgan

I think last quarter down payment assistance was about 33% in 2Q, I was just wondering what that number was for the third quarter?

Bruce Gross

The third quarter number was about 45% and that’s 45% of the 87% of loans we originated.

Operator

Your next question comes from the line of Josh Levin - Citigroup

Josh Levin – Citigroup

As you look at the economic and housing market landscape on both the challenges and opportunities, how do you think about the possibility of the [issue] of equity over the next year?

Stuart Miller

Everything is on the table all the time in a market like this. We’ve seen tremendous volatility over the past couple of weeks. Looking ahead we’re just not making any projections right now as to anything that we might or might not do. Fortunately as we’re situated today, we’re in a good cash position. Our balance sheet is strong and we don’t have immediate need for cash but I’m not going to take anything off the table either.

Josh Levin – Citigroup

As far as I know you haven’t been on the road talking to investors in quite some time, but as I understand it you’re thinking about going out on the road and talking to investors in the fourth quarter, what’s the logical rationale behind your decision to go out now on the road, after such a long absence?

Stuart Miller

I don’t know that it would be considered an absence. What we have done over the past couple of years is we’ve said we are more then happy to talk to investors at any time over the phone or here in our offices and we’ve had a number of investors come through and sit and go through our program.

It hasn’t been an absence; we just haven’t been out on the road. Our primary focus has been to manage our business and manage our operations and this has been an extremely full time job, seven days a week, working long hours. So the reason for the absence from presentations and the conferences has been so that we can focus our attention on running our business.

Now the fact that we’ve always been a participant in conferences and should we decide to join back in, it’s only because we have the time to do that because so much of the work that we have been working on is now effectively completed.

Operator

Your next question comes from the line of Chris Hussey – Goldman Sachs

Chris Hussey – Goldman Sachs

You mentioned you thought there would be a 10% to 15% impact on the housing market from down payment assistance going away, do you mean that you think that new home sales, that’s statistic could go down another 10% to 15% just from down payment assistance going away?

Stuart Miller

There are too many factors to really—I can’t project what the number of new home sales is going to be and this is an estimate, its just seemed to us by looking through the numbers that we’re able to see, that its somewhere in the 10% to 15% range of potential buyers that are taken out of the market.

Now will there be other things that come along that stimulate purchase that offset that? We’re just not sure but it seems like it’s not an insignificant impact.

Chris Hussey – Goldman Sachs

Around cash flow and I think you mentioned you had made about $200 million of land purchases, from your JVs during the quarter, just trying to get your strategy there in terms of—what is your strategy in terms of cash preservation? Your cash balances have stayed relatively flat but they’re not growing as fast as they have been earlier in this cycle. Do you feel like you have the right amount of cash and now its time to take advantage of some of these land purchases or how should we think about that?

Stuart Miller

No we’re not taking advantage of land purchases in the market. There will be that opportunity in due time and I think that we’re really neatly positioned to be out there working through some of the distress as it presents itself and it will. I’ve noted before we’ve maintained our management team to be able to go out and take advantage of the market conditions as they ripen but we don’t think that now has been that time.

Where we have used some cash is in preservation of value and opportunity that exists within our portfolio and what I’ve tried to highlight is that within our joint ventures some of those ventures have been [stressed] either through venture partners that simply don’t want to continue on. We saw that certainly with the [Hunter’s Point] joint venture or we’ve seen venture partners that simply don’t have the liquidity to move on.

And rather then abandon value or opportunity; we’ve used capital to opportunistically improve our position. So that’s the difference between what we’re saying and maybe what you’re seeing reflecting in the numbers.

Chris Hussey – Goldman Sachs

Do you have any tax refunds that you can get this year that might trigger another big land sale like you did last year or is that all the way by the books now?

Stuart Miller

We don’t anticipate a land sale of that kind of magnitude.

Operator

Your next question comes from the line of Nishu Sood – Deutsche Bank

Nishu Sood – Deutsche Bank

I wanted to follow-up and ask about the call it the next generation RTC type vehicle that‘s being debated even today, there is the possibility that it will include the purchases of development and acquisition loans and may end up therefore unloading land like what happened in the early 90’s, now this is on top of a situation where a lot of capital has already lined up to buy these assets so I imagine it would have a big impact, I wanted to get your thoughts on the potential behavioral impact. Does this freeze the market as people kind of assess and wait to see what this vehicle is going to do from a builder perspective for example, would you prefer to be buying it from a—prefer to replenish your land portfolio by buying from this next generation RTC versus the distressed funds that are being set up? I just wanted to get your thoughts on the behavior and how it changes the landscape.

Stuart Miller

First of all its interesting I agree with you, there’s a lot of capital that is kind of lined up on the sidelines but it is neatly tucked away on the sidelines in large part because that capital doesn’t quite know how to—in large measure doesn’t know how to look at a diverse array of portfolios or properties that are out there.

And so that capital is going to have to find a machine. The question is will the capital find machines, meaning management teams that are able to convert what is distressed land assets, undeveloped land assets, into developed home sites. I think at the end of the day if you look at where kind of we’re headed, our primary business will be looking to buy developed home sites from a land machine that is able to develop home sites and offer them at an appropriate price.

We are clearly going to have to wash a lot of land through whatever distress program is out there before we have an appetite to purchase those developed home sites. I think across the country we’re seeing a mismatch between what it takes to buy a home site and make a gross margin versus what sellers are willing to or perhaps are able to sell for and so its really going to be washing through distress, through these capital reservoirs that purchasing, and marrying up with the machine to actually develop home sites at a price that a homebuilder can make a margin on.

I’ll say additionally that other parts of our company will probably be participatory in that process and its one of the things that we’ve maintained is that land machine focus, to marry up with capital.

Nishu Sood – Deutsche Bank

This sounds a little more conservative let’s say, if you take your Lennar’s historical actions on a strategic scale. You’ve tended to do things directly and on a larger scale so, am I hearing you correctly? Is this a more kind of conservative stance going forward compared to the historical profile?

Stuart Miller

No I think that if you go back to the early 90’s and you look at the way that we emerged from the distress market in the early 90’s, we did exactly what I’ve just described. We came out of that distress period and we combined our operating machine with capital reservoirs that were available and ready to get involved in the distress. You might or might not even know but we actually grew an entire company that became well, it became [L&R] out of that early distress.

And we’re looking at it very much the same way.

Nishu Sood – Deutsche Bank

In terms of promotional activities, we’ve been hearing from some of the other builders that promotional activities are wearing out in their effectiveness. National sales drives for example since so many people are doing them have been losing their effectiveness. You had even mentioned last one or two quarters ago when we spoke about shifting more to incentives along the lines of financial services, the government’s $7,500 tax credit obviously stacks up very poorly against what the builder is already doing so I just wanted to get your thoughts on what marketing tactics are working right now if any, and how are you shifting your behavior in response to that?

Stuart Miller

As I noted, June and July were just beyond our expectations in how far they had fallen off. August showed an uptick and it was primarily because of promotion and I’d be surprised if that isn’t the case with other builders as well. It was a promotion that was geared towards the down payment assistance and getting under the wire of its elimination. And this was across the country and multiple builders and not in concert; I’m just saying that we noted that in a lot of places our competitors were doing the same.

So what promotions are working? The answer to that question is it’s a day by day evaluation. Each new data point in the marketplace gives rise to the next promotion. Hopefully at some point what will resonate with buyers is a combination of the fact that home prices are really at a very, very low point right now, especially new home prices. And put that together with a mortgage program that works for them and the availability of down payment money and they’ll step up and buy homes.

But that’s not for right now.

Operator

Your next question comes from the line of Megan McGrath – [Barclay’s Capital]

Megan McGrath – [Barclay’s Capital]

On the follow-up on your JV recourse that you talked about, how you’re three-quarters ahead and have gotten it down to around 492, I’m wondering if you can give us a sense of the mechanism by which you’ve reduce that? How much of it was cash that you used to pull down inventory and the debt came away, how much of it was accounting perhaps moving it from recourse to non-recourse?

Bruce Gross

The number we’re comparing to was last quarter was $807 million of maximum recourse indebtedness with unconsolidated JV’s. This quarter it was $630 million. The number you mentioned was net of reimbursement agreements which is not in the covenant calculation. So we’re looking at a reduction of about $177 million and we paid about $58 million of cash relating to that reduction. So it’s a cash component relating to that and then additionally it had different land sales, land splits, etc. that would be the remainder.

Megan McGrath – [Barclay’s Capital]

What are those numbers? Do you have those numbers available versus let’s say the fourth quarter of 2007?

Bruce Gross

I don’t have them on the call here, but I’d be happy to follow-up with you.

Megan McGrath – [Barclay’s Capital]

You mentioned in your last 10-Q that you may have to take a FAS 109 charge at the end of the year, now that we’re one more quarter in, do you have any feeling on the likelihood that you might have to write that asset down?

Bruce Gross

No we do not. That’s something that we’ll review with our auditors as we get to the end of the year.

Operator

Your final question comes from the line of Jay McCanless – FTN Midwest Research

Jay McCanless – FTN Midwest Research

On the distress land assets you were discussing before, I wanted to know if you’ve heard more from bank workout teams if the activity from the bank side is ticking up?

Stuart Miller

No. I think that the banks—are you talking about in terms of selling assets?

Jay McCanless – FTN Midwest Research

Correct.

Stuart Miller

No, I think that the banks are pretty much immobilized right now and maybe this is out of school for me to say, but I think that banks are concerned with maintaining Tier 1 capital right now and the impairment to the assets on their books could probably—it’s a matter of survival right now.

Jay McCanless – FTN Midwest Research

In your prepared remarks you discussed that your competitive forces in certain areas whether its builder competitors or resales or new home communities are declining, are there areas of the country that are more clear for Lennar or I guess a more clear playing field for Lennar then others?

Stuart Miller

What do you mean by a more clear playing field?

Jay McCanless – FTN Midwest Research

In terms of less communities, say private builder bankruptcies opening it up for Lennar to go out and build more homes etc?

Stuart Miller

I think that that would apply to almost every market that we’re in. It is very clear that the smaller builders are pulling back, if not going out of business. We’re seeing this in all communities, over all geographies right now and in terms of the number of communities, as communities are burned off there are just no replacements out there.

Thank you everybody. We appreciate your attention relative to our third quarter and look forward to another productive quarter in the fourth. Thank you and goodbye.

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Source: Lennar Corporation F3Q08 (Qtr End 08/31/08) Earnings Call Transcript
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