Q1 2017 Real-Time Call Brief

Highlights

Interestingly, the front page of U.S.A Today reports today that 60% of millennials ages 18 to 35 are living with parents, relatives and roommates and that is a 115-year high.

Our sales were up 11% year-over-year before WCI, 12% including WCI, driven by our strategy of driving better quality traffic through our digital marketing efforts.

Interestingly, our internet leads were up 18% year-over-year to about 100,000 for the quarter.

Our social media followers were up 17% year-over-year to 2.8 million on an annual basis and YouTube views were up by 10 million for the year.

While we match production with sales pace, we continue to maximize our gross and net margin at 21.1% and 10.8% respectively as we maintain higher sales price in order to maximize returns on our valuable land assets and we manage costs by striving to be the builder of choice to the trades in each of our markets.

The purchase price for WCI totaled approximately $643 million which we funded with cash and we also assume $250 million in senior notes.

We acquired over 13,500 home sites, adding 51 actively selling communities and an additional pipeline of future community openings for the next several years.

When we closed the acquisition, we acquired 361 homes in backlog with an average sales price of $516,000, totaling $188 million in near term revenue and cash flow.

Based on our due diligence and work to date, we expect to save between $8 to $12 per square foot or 200 to 300 basis points on new starts once the re-bidding process is completed.

While there will be some upfront costs associated with implementing these changes, we anticipate annualized savings of approximately $30 million beginning in late 2017.

I wanted to say we've noted before that our strategy remains a clear pivot in land strategy towards a shorter term land acquisition and towards a 7% to 10% growth strategy.

We've also refocused on expanding our first-time buyer offering with our mix now standing at right around 40%.

Financial services results exceeded last year's first quarter result by 38%, driven in part by increased profitability in title operations and Bruce, who overseas this operation, will give additional color in his portion.

As noted in our press release, this segment generated $19.2 million in pretax income, up 57% from last year as we sold another two communities under our merchant build program.

During the first quarter, we started some 1,373 apartments in five communities with a total development cost of approximately $600 million.

As of February 28, 2017, we had a geographically diverse pipeline of 74 communities, totaling almost 23,000 apartment homes with a total development cost of almost $8 billion.

We're gearing up our build-to-core program that we've discussed in the past with some 20 communities for 6,000 apartments already under construction to fill the $2.2 billion equity bucket with geographically diversified A-located, brand new and modern apartment communities in a generally shelter constrained environment.

Rialto contributed $12 million to the bottom line this quarter as market conditions favored this business segment as well.

Additionally, market conditions particularly favored Rialto Mortgage Finance, as that exceptionally run team which is focused on the commercial mortgage conduit business, exceeded expectations and closed three transactions totaling $478 million.

Revenues from home sales increased 13% in the first quarter, driven by a 13% increase in wholly-owned deliveries and a consistent average selling price of $365,000.

Our gross margin on home sales in the first quarter was 21.1% and as Stuart mentioned, we're still on track with our previously stated gross margin goal of 22% to 22.5% for the full year.

Our gross margin percentage was impacted 10 basis points due to the write-off of WCI backlog inventory that closed during the first quarter.

Sales incentives were 5.9% this quarter compared to 5.6% in the prior year, but it improved sequentially from our fourth quarter total of 6.2%.

Direct construction costs were up 4% year-over-year to approximately $55 per square foot and that was driven by approximately a 6% increase in labor and 3% in material costs.

SG&A percentage, as a percent of home sale revenue in the first quarter, was 10.3%.

Included in the SG&A in the first quarter were one-time expenses related to the WCI acquisition, mainly offset by one-time legal and insurance benefits resulting in a net one-time charge of approximately $2.7 million or 10 basis points impact to SG&A percent during the quarter.

Other income was $5.7 million compared to other expense of $600,000 in the same period last year.

Equity and loss from unconsolidated entities was $11.5 million which included our share of net operating losses from JVs as they incurred G&A costs while ramping up for our future land sales.

During the quarter, we opened 58 new communities and added 51 net communities from the WCI acquisition to end the quarter with 752 net active communities.

New homeowners increased 12% and new order dollar value increased 16% for the quarter.

Our sales pace was higher compared to the prior year at three sales per community per month versus 2.9 and that improved sequentially throughout the quarter.

The cancellation rate was 16%.

In the first quarter, we purchased approximately 8,300 home sites, totaling $659 million and just to note, the first quarter usually has the largest dollar amount of land purchases for the year.

Including the home sites from the WCI acquisition, our home sites owned and controlled now total 173,000 home sites, of which 137,000 are owned and 36,000 are controlled.

We now have approximately 4.6 years' supply of land owned based on this year's projected deliveries.

Our completed unsold homes at the end of the quarter were in our normal range of one to two per community, totaling 1,342 homes.

Financial services, this segment had strong results with operating earnings of $20.7 million compared to $14.9 million in the prior year.

Mortgage pretax income increased slightly to $13.4 million from $13 million in the prior year.

Mortgage originations increased to $1.8 billion versus $1.7 billion in the prior year and the capture rate of Lennar home buyers was 81% compared to 82% in the prior year.

Our title companies profit increased to $6.8 million during the quarter from $2 million in the prior year and this was driven by a 15% increase in revenue during the quarter and the associated overhead leverage from this higher volume.

Rialto segment and providing more details, the operating earnings were $12 million compared to $1.9 million in the prior year, both amounts are net of non-controlling interests.

The Investment Management business contributed $34.4 million of earnings, primarily due to $33.4 million of management fees and other and this included $10 million of carried interest received in the quarter relating to Fund One.

At quarter end, the undistributed hypothetical carried interest for Rialto Real Estate funds one and two now totals approximately $125 million.

Rialto Mortgage Finance contributed $478 million of commercial loans into three securitizations, resulting in earnings of $33.2 million compared to $380 million and $3.9 million in the prior year respectively and these are both before their G&A expenses.

The increase in earnings was primarily due to an increase in volume and average net margins of the securitizations from 1.6% in the prior year to 7.1% in the first quarter.

Our direct investments had a loss of $15.9 million during the quarter as we continued to work towards monetizing the remaining assets purchased from early portfolios.

Rialto G&A and other expenses were $33.3 million for the quarter and interest expense, excluding warehouse lines, was $6.4 million.

Rialto ended the quarter with a strong liquidity position with $163 million of cash.

The $19.2 million of operating profit in the quarter was driven by the segment's $26 million share of gains from the sale of two operating properties as well as management fee income partially offset by G&A expenses.

Our tax rate for the quarter was 34%.

The rate is higher than the prior year's rate of 28.1% because the prior year had one-time adjustments due to an IRS settlement and energy credits.

We expect the tax rate to be 34% approximately for the remainder of 2017.

We had a net debt to total capital of 41.6% which was an improvement of 370 basis points over the prior year.

Our liquidity strength provides exceptional financial flexibility with over $640 million of cash and only $250 million of borrowings on our $1.5 billion committed revolving credit facility.

Additionally, we grew stockholders' equity by 24% year-over-year to $7.2 billion and our book value per share grew to $30.70 per share.

The preliminary goodwill estimate from the WCI acquisition is $150 million to $175 million and that's subject to revision as it is still being reviewed, both internally and externally.

During the quarter, we issued $600 million of 4 1/8% senior notes due 2022 and we added $250 million of 6 7/8% senior notes due 2021 as part of the WCI acquisition which we're likely to refinance at the next call date in August.

Starting with deliveries, we're increasing our delivery goal to between 29,500 and 30,000 homes for 2017.

We expect the backlog conversion ratio to be approximately 75% to 80% for the second quarter, 75% to 80% for the third quarter and over 90% for the fourth quarter.

We're still expecting an average sales price between $365,000 and $370,000 for the full year and we're right on track with our operating margins of around 13% for the full year.

As a result, we expect our second quarter gross margin percentage to be between 21% and 21.5%, while the full-year gross margin is still expected, as I mentioned, to be 22% to 22.5%.

We still expect continuing improvement in the SG&A line from operating leverage and our investments in technology, reducing SG&A to between 9.1% to 9.3% for the full year.

The second quarter will have some non-recurring transition costs relating to the WCI integration, therefore, we expect SG&A to be approximately 9.5% in Q2.

Financial services, we're increasing the goal to approximately $160 million for the year with the second quarter expected to be approximately $40 million.

We're adding WCI to our mortgage platform, although keep in mind, 50% of the WCI buyers use all cash and we will focus on capturing a high percentage of the other 50% that require a mortgage.

Rialto is still expected to generate a range of profits between $45 million and $55 million for the year, with the second quarter expected to be approximately $5 million.

Multi-family is still expected to be between $70 million and $80 million for the full year, the second quarter is expected to be also approximately $5 million which includes one apartment community sale.

The category of joint ventures, land sales and other income is still expected to be in a range of $70 million to $80 million of profit for the year.

However, the second quarter is expected to have net expenses of $15 million to $20 million, while the second half of 2017 is driving all the profit for this category.

Corporate G&A is still expected to be 2.2% to 2.3% and our net community count is expected to end the year between 770 and 780 communities.