Earnings Call
Lennar Corp /New/ (LEN)
Earnings Call Transcript - LEN Q2 2023
Operator, Operator
Welcome to Lennar's Second 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 David Collins for the reading of the forward-looking statements.
David Collins, Controller and Vice President
Thank you, and good morning, everyone. Today's conference call may include forward-looking statements, including statements regarding Lennar's business, financial condition, results of operations, cash flows, strategies, and prospects. Forward-looking statements represent only Lennar's estimates on the date of this conference call and are not intended to give any assurance as to actual future results. Because forward-looking statements relate to matters that have not yet occurred, these statements are inherently subject to risks and uncertainties. Many factors could affect future results and may cause Lennar's actual activities or results to differ materially from the activities and results anticipated in forward-looking statements. These factors include those described in our earnings release and our SEC filings including those under the caption Risk Factors contained in Lennar's annual report on Form 10-K most recently filed with the SEC. Please note that Lennar assumes no obligation to update any forward-looking statements.
Operator, Operator
I would now like to introduce your host, Mr. Stuart Miller, Executive Chairman. Sir, you may begin.
Stuart Miller, Executive Chairman
Very good. Thank you, and good morning, everyone. Sorry about the delay. We had a lot of people joining. Wanted to make sure if people had an opportunity to get in. I'm in Dallas today together with Jon Jaffe, our Co-CEO and President, and we're joined remotely from Miami by Rick Beckwitt, our Co-CEO and Co-President, Diane Bessette, our Chief Financial Officer, David Collins, our Controller and Vice President, and Bruce Gross, our CEO of Lennar Financial Services. As I said, they are all in Miami, so there will be a bit of coordination here. As usual, I'm going to go ahead and give a macro and strategic overview of the company. After my introductory remarks, Rick's going to walk through our markets around the country, comment on our land position. Then John's going to update supply chain, cycle time, and construction costs. And as usual, Diane will give a detailed financial highlight, along with some limited guidance for the third quarter to assist in forward thinking and some guidance for the year. And then we'll answer questions, as many as we can. As usual, please limit yourself to one question and one follow-up so we can get as many in as possible. So let me go ahead and begin by saying that we are quite pleased to report that the Lennar team has remained focused on production and pace, cash flow, inventory turns, and return on capital, and we have again produced strong and consistent results for the quarter. Our second-quarter results are consistent with the stabilization we have seen in the current economic environment, as well as consistent adherence to our core operating strategies that we've discussed on prior quarterly conference calls. As it relates to home building, the economic environment has stabilized as customers have adjusted to and accepted higher-for-longer interest rates. The supply chain chaos has normalized, inventories have remained low, and the supply of housing across the country is in very limited supply. This environment seems to represent a new normal that has formed in the wake of the Federal Reserve's aggressive interest rate hikes starting last year. While persistent inflation remains in the system, aggressive rate hikes have given way to moderated and measured rate movements, allowing the market to adjust in an orderly fashion. The strong demand for housing that had been curtailed by sticker shock and affordability challenges has returned, while the housing market adjusted prices, incentives, including rate buy-downs, and production costs in order to enable customers to afford needed shelter. And even while interest rates and affordability were primary headwinds to demand, the well-documented chronic housing supply shortage has kept inventory levels very low, which has continued to propel customers to stretch their finances for needed housing, as incentives and price reductions combined to spark sales activity. The net price of homes has moderated through price reductions together with the use of interest rate buy-downs and other incentives, and the net average sales price has stabilized and not gone higher nor lower for that matter, even as demand has returned. We have seen in our numbers that net average sales prices on home closings have dropped approximately 10% or 11% on home sales from the peak of approximately $500,000 in 2022 to approximately $450,000 now, and we expect that that pricing is going to remain constant throughout the year. I would note additionally that through our multifamily apartment division, we are also seeing that rental rates have moderated. Given our extensive experience in the multifamily apartment market, along with our for-sale and for-rent housing business, we see that there is general downward pressure on rents, as many markets have become somewhat overbuilt and there is additional inventory being completed and coming online. This inventory will complete over the next year and a half. While rents won't likely drop significantly, they are not likely to grow very much either. Remember that rentals and rent equivalents make up a significant part of the CPI calculation. Overall, we believe that the housing market has leveled and while net average sales prices are lower, cancellations have been normalizing and margins have bottomed and are recovering as cost reductions and value engineering provide an offset to the price reductions. Looking ahead, we continue to believe that the market and the economy will remain constructive for home builders as pent-up demand continues to come to market and consume affordable offerings. Additionally, we believe that the supply constraint will continue to limit available inventory and maintain supply-demand balance. The core elements of the supply shortage will not resolve in the near term as the almost 15-year production deficit will take years to resolve. And note that even when existing homes with low-interest mortgages that are not currently trading do come to the market and add to supply, the sellers will also need a place to move and that creates a net zero to overall dwellings, in addition to supply and in addition to demand and therefore still a housing shortage. Bottom line, supply is short, demand is returning to affordable offerings and builders will need to produce more homes to fill the void. Against this backdrop, the Lennar team has remained consistent in our commitment to strategies that we articulated as rates began to climb over a year ago. Let me do a quick review as these strategies explain both what we have accomplished as well as what we expect to accomplish throughout the remainder of the year. First, we said then, as we say now, that we maintain volume and production as our constant and margin as our shock absorber, and we manage our business with certainty through volatility staying focused on production, inventory turn, cash flow, and return on assets. Accordingly, we maintain volume, keeping our production machine working efficiently while rationalizing costs. In the second quarter, our sales team engaged our digital marketing platform in conjunction with our dynamic pricing model to continue to drive sales volume at market pricing in order to maintain consistent production levels and improve our inventory turn. We affectionately call this configuration the Lennar machine, and it is designed to produce consistent sales pace at pricing that enables consistency as the market adjusts. Although it is not perfect yet, the Lennar machine drove new order volume to 17,885 new orders exceeding last year's volume by 1% and this enabled our production group to operate with predictability and consistency. Additionally, we efficiently backfilled cancellations in the quarter, which have now dropped to about 13.5% enabling our deliveries to exceed expectations at 17,074 deliveries and that was up 3% over last year. If by chance, by the way, any of you happen to be in Miami, come on by and ask to see the Lennar machine in action. I think you'll get a better sense of our strategy, and you just might start to imagine where the often talked about AI might find its way into the sometimes stodgy home building industry and improve productivity. And to this end, we have a new and exciting Chief Technology Officer at Lennar named Scott Spradley. Welcome aboard, Scott. Let's get to work. We've continued to focus on selling homes at market clearing prices, reducing margin when conditions weaken, and improving margin as conditions level and improve. Accordingly, our margins bottomed in the first quarter at 21.2%, then as the market leveled this past quarter, we saw margin improvement to 22.5%, and we're expecting further improvement next quarter to 23.5% to 24%, and further improvement beyond that, of course, depending on market conditions. Through all phases of the market cycle, we are consistently producing strong cash flows. The elements of execution are working extremely well and improving with the Lennar machine, and we've gained confidence in our ability to now guide to increased volume for the year of 68,000 deliveries to 70,000 deliveries with strong margins and strong cash flow. Our second strategy has been to work with our trade partners to right-size our cost structure to the current sales price environment, while we continue to drive our cycle time to pre-supply chain crisis levels. John will cover this strategy in more detail shortly, but John and Rick have been focused across our platform with our production and our purchasing teams, as well as our trade partners. Considerable results are reflected both on the margin improvement and in the number of homes that were construction-ready and available for delivery. On the margin front, since Lennar led the way with a reduction in margin while maintaining volume and increasing market share, as the market corrected in the wake of an industry-wide reduction in starts, we engaged our trade partners to work side by side with us to help find efficiencies in production, to right-size their margins as well, and to work side-by-side in driving efficiencies on the site. As margin expanded in the best of times, they benefited. As margins have now contracted in the more difficult times, we all understand the benefits of predictability and consistency derived from consistent volume and scale. Cycle time continues to be a work in progress. While we continue to make improvement, we improved from 219 days last quarter to 215 days this quarter; this is truly like fixing a plane that is in flight, as progress is slow and difficult to measure as products change. Nevertheless, we're making slow but steady progress as improvement will help reduce inventory turn, which now stands at 1.2 versus 1.1 last year. Our third strategy is to sharpen our attention on land and land acquisitions, as well as on land and land bank strategy. While Rick will give additional detail on land, this has been a specific concentrated focus by all three of us, myself, Rick, and John, across the platform, working connected and together to refine our approach to reducing land exposure and becoming increasingly asset light. We've made significant progress in reducing land held on our balance sheet, with now 70% of our land controlled and only 30% owned. As with our trade partners, our land partners or sellers have become strategic partners in maintaining volume and increasing market share while helping to rationalize costs. Our fourth playbook strategy was to manage our operating costs, or our SG&A, so that even at lower gross margin, we will drive a strong net margin. While we've been driving our SG&A down over the past years, quarter by quarter, to new record lows, and many of those changes, although not all, are hardwired into permanent inefficiencies in operations, there are some components that have grown as we've had to address more difficult market conditions. Examples, of course, are realtor costs and marketing expenses, which have had to expand as customer acquisition has become more challenging. Nevertheless, we were able to achieve a respectable 6.7% SG&A this quarter, which resulted in a strong net margin of 15.8% after net. We know that in more difficult times, there is and should be upward pressure on sales and marketing costs in order to drive and find purchasers and drive new sales. We believe, however, if we continue to drive volume, we'll be able to constrain increases and manage to a very attractive cost level and net margin. Our fifth playbook strategy was to maintain tight inventory control, and the Lennar machine of digital marketing, sales management, and dynamic pricing has materially improved inventory control by enabling a focus on selling homes in inventory, focusing maximum attention on underperforming communities, and bringing attention to product plans that are simply just not selling. Clearing the homes that are complete and closable rather than selling homes that are many quarters in the future is exactly what drives cash flow, and we're focused on this part of our business every day. Both land and home inventory control is mission central for our overall business, and in our second-quarter numbers, you can see in our continuing quarterly improvement in our now 13.3% debt to total capitalization ratio down from 14.2 last quarter and our $4 billion cash position that our inventory and our balance sheet is being carefully managed to provide excellent liquidity and flexibility for our future. These elements of business continue to be managed through every other day management meetings, where numbers are reviewed at the regional and divisional levels by the entire management team. Starts, sales, and closings are maintained in a controlled balance with the end result of volume with defined expectations. The sixth playbook strategy was to continue to focus on cash flow and the bottom line in order to protect and enhance our already extraordinary balance sheet. If we reflect on our second-quarter results, we not only accomplished excellent cash flow and bottom line results, but we repurchased $208 million of stock and we also repurchased approximately $158 million of senior debt due in fiscal 2024. We expect to continue to generate considerable earnings and cash flow and accordingly, will continue to retire debt and purchase stock opportunistically. Let me say in conclusion that our second quarter of 2023 has been an excellent quarter for Lennar. We saw market conditions level and stabilize at least for now, and we executed on our core strategies. We are extremely well positioned to navigate the uncertainties of the current market. We engaged the difficulties of the past year with a consistent strategy that promoted certainty of execution throughout the company. When market conditions were difficult and uncertain, Lennar associates knew their mission. Similarly, as the market has leveled, Lennar associates know the mission and exactly how to execute. Our strategy is well known and understood through our division offices and we have a plan as the inevitable cycles of our industry even and flow. We focus on maintaining volume while we price our homes to drive a consistent pace. We work with our trade base to manage costs and inefficiencies and efficiencies. We manage both our land and our production inventories to drive cash flow and returns on investment. We focus our asset light model in order to drive balance sheet efficiency and drive return on investment. Finally, we fortify our balance sheet to have liquidity for strength and flexibility. Knowing what to do and executing per plan has driven this quarter's success and continues to guide us into the next quarter and beyond. We are confident that we will continue to perform and drive Lennar to new levels of performance. Thank you and now let me turn over to Rick.
Rick Beckwitt, Co-CEO and Co-President
Thanks, Stuart. As you can tell from Stuart's opening comments, the housing market has continued to normalize and recover as buyers have become more comfortable with higher mortgage rates. Tight inventory levels in the resale and new home market propel demand for available new homes, and we offered a combination of attractive pricing and compelling mortgage rate programs to capture that demand. While many of our markets are performing well, in all of our markets we are regularly adjusting base prices and incentives to maintain our targeted sales pace. Our strategy has been to maintain our targeted start phase, continue to sell homes, and adjust our pricing to reflect market conditions. In that sales with starts, we have used the dynamic pricing model and the Lennar machine that Stuart just previewed to continuously find the market clearing price of each of our homes on a community-by-community basis as quickly as possible. We fundamentally believe that our price to market strategy reflects our balance sheet first focus, where we can maximize starts and sales, increase market share, generate cash flow, and keep our home building machine going. With this end, John will discuss the operational and cost benefits of maintaining our start phase. Our second quarter results reflect the successful execution of our price to market strategy. During the quarter, our new sales orders increased 1% from the prior year and 26% from the first quarter with the first and second quarter seasonal change exceeding our historical average over the last three years. New orders increased sequentially in each month during the quarter. Our sales pace for community averaged 4.8% in the second quarter, down 4% from the prior year but up 23% from the first quarter. Our second-quarter new sales price decreased 11% from the prior year and was up a slight 1% from the first quarter. Our cancellation rate during the quarter totaled 13.5%, which was a significant improvement from our first quarter. All of these operating comparisons reflected stabilization and normalization across our markets and Lennar's continued focus on using price and incentives to achieve our targeted sales pace per community. These results compare very favorably to nationally reported results and highlight the increase in our market share across our footprint, driven by a carefully crafted starts and sales program. Our sales activity and cancellation rates in the first few weeks of June have been consistent with our second quarter results. And now I'd like to give you an update on our markets across the country. In prior quarters, I described three categories: one, markets that are performing well; two, markets that are performing but require slightly higher pricing adjustments and incentives to maintain our targeted sales; and three, markets that require more aggressive pricing adjustments, incentives, and repositioning to regain momentum. In the second quarter, we did not have any of the category three markets. During the second quarter and so far in June, we've had 14 markets that are performing well. These include Southwest Florida, Southeast Florida, Tampa, Palm Atlantic, New Jersey, the Philly metro area, Charlotte, Raleigh, and Coastal Carolinas, Indianapolis, Dallas and Houston, Phoenix, and San Diego. These markets are benefiting from low inventory, and many are benefiting from a strong local economy, employment growth, or in-migration. New sales in these markets reflect more normalized incentives, which may include closing costs, assistance, and minor mortgage rate buy-downs in order to maintain sales momentum. In the second quarter, we had 26 category two markets. While many of these markets have improved relative to the first quarter and are meeting our sales targets, they still require higher pricing adjustments and incentives than our category one markets. Our category two markets include Jacksonville, Ocala, Orlando, Gulf Coast, Northern Alabama, Atlanta, Virginia and Maryland, Chicago and Minneapolis, Nashville, Austin, San Antonio, Colorado, Tucson, Las Vegas, California Coastal, the Inland Empire, the Bay Area, Central Valley, Sacramento, Portland, Seattle, Utah, Reno, and Boise. While inventory is limited in each of these markets, we've had to offer mortgage rate buy-downs, base price reductions, closing costs, and other incentives to maintain momentum. The size of the adjustment can vary on a community-by-community basis and it's often been limited to specific homes each week. We've been very proactive and worked closely with Lennar Mortgage to create highly attractive, cost-efficient, and timely financing packages that have enabled us to offer attractive purchase prices for our customers. This hands-on coordination between our sales and mortgage teams has enabled us to sell our homes quickly and avoid building up finished inventory. Before I turn it over to John, I'd like to discuss our land strategy and community count. Much of our balance sheet and inventory management progress is driven by the execution of our land strategy while simultaneously driving sales, delivery and managing production. Quarter after quarter, we have worked with our strategic land partners and land banks to develop relationships for them to purchase land on our behalf and deliver just-in-time finished home sites to our home building machine on a monthly and quarterly basis. In the second quarter, about 90% of our $1.2 billion land acquisition was finished home sites purchased from various land structures. We continue to make significant progress on our land strategy. This was evidenced by our second quarter ending years supply of home sites improving to 1.7 years from 2.4 years prior year and our controlled home site percentage increasing to 70% from 60% for the same time period. I would like to conclude by discussing community count. Our community count at the end of the second quarter was 1,263 communities, which was up 3% from the prior year period, and we expect to increase our community count in the high single digits by the end of fiscal 2023 from the end of fiscal 2022. As I mentioned last quarter, the bulk of these communities will come online in the fourth quarter. I'd now like to turn it over to Jon.
Jon Jaffe, Co-CEO and President
Thank you, Rick. As Stuart and Rick discussed, Lennar's operations have continued the steady execution of maintaining our starts and sales pace. Our strategy is to price homes to market so our construction machine can operate smoothly without the disruptions of stopping and restarting. This strategy enabled us to reduce our direct construction costs as expected, delivering gross margin improvements in the quarter. While we achieved some gross margin benefit in Q2 from cost reductions, a greater amount of cost reductions will impact margins equally in Q3 and Q4 based on the timing of when homes were started. As noted, our quarterly starts and sales pace were 5.3 homes and 4.8 homes per community respectively. Utilizing the Lennar machine, we focused on the orderly selling of homes at the right pace, so homes are sold prior to their completion. This process allowed us to not build up excess finished inventory as we ended the second quarter with approximately one inventory home per community, consistent with our Q1 ending inventory level. Our strategy of maintaining starts also plays a major role in gaining access to the labor we need and is the foundation for our previously stated objectives of lowering construction costs, reducing cycle time, and achieving even and flow production. While Lennar starts were down year-over-year for the first half of 2023, industry-wide start levels were down 100% more than Lennar's. We've heard from our trade partners how important it is to them that we have maintained starts in all of our communities and all markets. Our production-first strategy has had a dramatic effect on Lennar being the builder of choice for trades. At many of our trade partners, Lennar represents over 70% of their business. These trade partners saw little to no decrease in their work while at the same time the industry start levels were contracting by 30%. Looking forward, we will continue to increase our starts and expect Q3 and Q4 starts to both be above 2022 levels. Looking at our second quarter, as expected, our construction costs fell sequentially from Q1 by about 3%. While our Q2 costs were up about 8% on a year-over-year basis, this was down significantly from the 13% year-over-year increase we had in Q1. Again, this is the trajectory of cost reductions we guided to last quarter. In addition to our trade partners stepping up with cost reductions, we also took our value engineering focus to a new level. While we have always value engineered our plans, we created a dedicated team as part of our national supply chain group to focus on this area. This team works hand-in-hand with our divisions both in the field and the office to drive cost and constructability efficiencies. Going forward, this team will focus on our core plan strategy. Rick and I were in Houston last week attending our Internal Annual National Supply Chain Meeting led by Kemp Gillis. There, we saw firsthand how this team has shifted from fighting the battle of supply chain disruptions to achieving the needed cost reductions to offset our sales price reductions. Now, this team is looking ahead and is fully engaged in initiatives that will impact our results in 2024 and beyond. This includes programs to structurally offset future cost increase pressures and to implement new technologies to both make the field process more efficient than ever and transform the way we manage information for the bidding process. We can report that there is a great intensity in this team and more focus on innovation than ever before. With respect to the supply chain, the second quarter had the least supply chain disruption since 2020. This was due to the combination of a steep decline in industry-wide starts along with manufacturers operating in much higher capacities for an extended period, augmented by Lennar supply chain strategies and communication. The lack of supply chain disruptions helped our continued reduction in cycle time. We saw modest improvement in our second quarter and expect to see a more meaningful improvement in the back half of the year. For the quarter, cycle time decreased by four days sequentially from Q1. As we move into our third and fourth quarters, we will benefit from greater cycle time reductions that are a primary driver for our increased guidance and deliveries for 2023. Additionally, we will start about 3,500 homes in Q3 that will reduce cycle time and allow us to have the appropriate inventory levels to achieve our delivery guidance. The reduction of cycle time in the back half of the year will also free up cash that is otherwise tied in our inventory, further strengthening our balance sheet. In the second quarter, we made meaningful progress in evolving from the production challenges of the supply chain disruptions for even flow production. While there is still meaningful progress to be made in obtaining even flow production from start to finish, I want to take this opportunity to recognize and thank all of our construction and purchasing associates for delivering one of the smoothest quarters of closings. All of us at Lennar are focused every single day on lowering costs, reducing cycle time, achieving even flow production, enabling improved margins as G&A efficiencies, a stronger balance sheet, and the delivery of high-quality affordable homes. I would now like to turn it over to Diane.
Diane Bessette, Chief Financial Officer
Thank you, Jon, and good morning, everyone. Stuart, Rick, and Jon have shared valuable insights about our home delivery performance. As always, I will take a few minutes to discuss the financial services results and highlight some of our accomplishments on the balance sheet, followed by some high-level thoughts for Q3. Starting with financial services, in the second quarter, our financial services teams reported operating earnings of $112 million. Breaking down the details, mortgage operating earnings reached $82 million, up from $74 million in the previous year. This increase was primarily driven by a higher profit per loan, attributed to higher secondary margins, despite a decline in loan volume. Title operating earnings were $33 million, compared to $30 million the prior year, mainly due to increased volume and lower cost per transaction as the team worked to gain efficiencies through technology. These strong results stemmed from effective collaboration between our home building and financial services teams, working together seamlessly in a challenging market. They exemplify our unified approach at Lennar. Now, moving to the balance sheet, we consistently emphasize the importance of returns on invested capital and cash flow at Lennar. This quarter, we remained focused on turning our inventory and generating cash by increasing production and pricing homes to market, enabling us to deliver as many homes as possible. Our commitment to preserving cash and enhancing asset efficiency remained steadfast, particularly with regard to land spending. We invested approximately $1.2 billion in land this quarter, with about 90% of these initial sites set for vertical construction soon. As a result, we concluded the quarter with $4 billion in cash and no borrowings on our $2.6 billion revolving credit facility, amounting to a total of $6.6 billion in home building liquidity. Our continued drive for balance sheet efficiency led us to enhance our goal of being land lighter. Our year's supply of homes improved from 2.4 years to 1.7 years compared to the prior year, while homes controlled increased to 70% from 68% last year. By quarter's end, we owned 117,000 home sites and controlled 207,000 for a total of 387,000. We believe this home site portfolio positions us well to grow market share in a capital-efficient manner. During the quarter, we started approximately 19,700 homes and ended with around 37,300 homes in inventory, including about 1,300 completed but unsold homes, managing our finished inventory levels effectively. In line with our strategic capital allocation commitment, we repurchased 2 million shares for $208 million and paid dividends totaling $110 million. In our ongoing effort to bolster our balance sheet by reducing debt, we repurchased $158 million in senior notes due in fiscal 2024 at prices below par. Over the past few years, we've repaid approximately $5.6 billion in senior notes, yielding around $300 million in interest savings. With strong earnings, our debt to total capital ratio was 13.3% at the end of the quarter, the lowest we've ever had, down from 17.7% the previous year. Before wrapping up, I want to highlight a few last points regarding our balance sheet. We remain dedicated to increasing returns, with shareholders' equity rising to $25 billion and our book value per share increasing to $87. Our return on inventory hit 28%, and our return on equity was 18%. In summary, our robust balance sheet, solid liquidity, and low leverage position us well for financial confidence and flexibility as we progress through 2023. Now, regarding our outlook for the third quarter, we expect new orders to fall between 18,000 and 19,000 homes, keeping our focus on meeting production goals. We anticipate our community count for Q3 to remain steady with the end of Q2, though, as Rick mentioned, we expect to see high single-digit growth year-over-year by the end of our fiscal year on November 30. We project Q3 deliveries in the range of 17,750 to 18,250 homes and are increasing our full-year delivery expectations to 68,000 to 70,000 homes, up from a previous forecast of 62,000 to 66,000. Our average sales price for Q3 should align with Q2 as we prioritize delivering affordable homes. We project Q3 gross margin to be between 23.5% and 24%, with ongoing impacts from cost-saving initiatives, although higher land costs will provide some offset as we acquire more finished lots. As is typical, we expect Q4 gross margin to be sequentially higher than Q3, although providing precise guidance is challenging at this point. We expect Q3 SG&A to range from 6.7% to 6.8%, and earnings from home building, joint ventures, land sales, and other segments to be approximately $25 million. Financial services earnings for Q3 are expected to be between $100 million and $105 million, with projected losses of about $10 million from our multifamily business and around $20 million from the Lennar Other category. Please note that this estimate for Lennar Other does not take into account potential market adjustments on our technology investments, which will be clarified by stock prices at the quarter's end. We anticipate Q3 corporate G&A to be about 1.4% to 1.5% of total revenue, and our charitable foundation contributions will be based on $1,000 per home delivered. Our expected tax rate stands at about 24.7%, and the weighted average share count should be roughly 284 million shares. All these estimates suggest an EPS range of approximately $3.35 to $3.50 per share for Q3. Now, let's open the floor for questions.
Operator, Operator
Thank you. We will now start the question-and-answer segment of today's conference. Our first question comes from Kenneth Zener from Seaport Research Partners. Please proceed.
Kenneth Zener, Analyst
As I understand the benefit of your even flow process, you're able to decapitalize your balance sheet, lifting inventory turns, which is consistent with our inventory turns equal alpha thesis. So my first question is, what do you consider to be the most efficient or targeted start pace long-term, giving starts equal orders, relative to 2Q's 5.3 pace that you set your margin shock absorber to, in your words?
Stuart Miller, Executive Chairman
Let me start by saying, Ken, that the even flow is a combination of becoming asset-light and having a very focused program on building our partner relationships. This approach enables consistency and predictability with our trade partners, allowing all of us to become more efficient. Your question pertains to the start pace. We consider the start pace as a program we will implement as we advance our understanding of both successful and less successful communities, along with their connection to sales and closings. This approach is largely driven by data and is continuously developing. Therefore, we cannot provide a specific number at this time. Instead, it's a concept we are working towards, iterating on, and utilizing extensive data feedback to arrive at figures that make sense across our 40 divisions and geographies, all collaborating in unison. Jon?
Jon Jaffe, Co-CEO and President
I would also add that it's very dependent upon community specifics and market specifics in terms of what's the right pace. So it might be a very different pace for Dallas than it is, say, for Seattle. And we very carefully measure that balance market by market so that we can match a sales pace and start pace according to market demand, land availability, labor availability.
Kenneth Zener, Analyst
I appreciate that there. It sounds like there's several layers to peel.
Stuart Miller, Executive Chairman
Yes, there are. And by the way, let me just say, it's handled with an every other day meeting and not just data feedback loops, but interpersonal feedback loops that are constantly in motion. But go ahead.
Kenneth Zener, Analyst
Right. No, no. It sounds like you have to be actually responsive to the trade in part. So second, considering your non-WIP inventory, owned lots fell about 20% year-over-year to 1.7 years, very impressive. And Diane, I'm very glad that you report and adjust out inventory units. So my question is, to what level can owned lots go in your even flow framework, given Rick's 90% finished lot purchase comment, if I heard that correct? And are you willing to kind of offer a goalpost for FY '24, perhaps implied cash flows, given you've been dropping almost 0.2 years' owned. Sequentially, it's very impressive.
Stuart Miller, Executive Chairman
Sure. Thank you. And Rick, why don't you go ahead and take that question?
Rick Beckwitt, Co-CEO and Co-President
We have a target out for FY 2024, yes. All I know is, as Stuart mentioned in his comments, Jon, myself and Stuart are laser focused on our asset-light balance sheet and continuing to improve the percentage of homesites we control versus own. We've developed some incredible relationships with our land partners and with our land banks that really have facilitated us to improve on these metrics.
Diane Bessette, Chief Financial Officer
I would like to add that while we haven't achieved this yet, our aim is to have our net income align with our cash flow as we move towards a more asset-light model and own fewer properties over time. Although we are not there currently, we are actively working on enhancing our performance to meet this long-term objective.
Stuart Miller, Executive Chairman
And let me just say that, look, we've set out a goal in terms of becoming an asset-light model. We report outwardly to all of you our progress along the way. But inwardly and in the background, we are working on not just relationships but structural programs to enhance the ability to manage an asset-light model and to continue to improve it. Where we will actually end up, we're not going to lay out timeframes and numbers, but you can expect that there is going to be continuous improvement in the space.
Operator, Operator
Next, we'll go to the line of Susan Maklari from Goldman Sachs.
Susan Maklari, Analyst
My first question is, it sounds like the supply chain is slowly improving, and you are seeing healing happening there. But it does feel like it's, in general, still fairly fragile. Are there lessons that you learned in the last couple of years that you can apply as the start pace does pick up from here so that you can make sure that you're not running into some of those same challenges that you faced and therefore, maintaining those inventory turns, maintaining that cash generation that you're looking to do?
Stuart Miller, Executive Chairman
Jon, why don't you take that?
Jon Jaffe, Co-CEO and President
Susan, first, let me say that from Lennar's perspective, it really feels like the supply chain disruptions are behind us with a few minor exceptions. And perhaps that's, as I noted in my remarks, due to our size and scale, working with manufacturers that are running at an extended period of time of full capacity. But there are definitely lessons learned as we had to scramble through the supply chain disruptions, we learned how to work differently with our manufacturers, providing them different types of forecasts, more visibility into what's coming as well as how we can create local distribution for them that really cuts down the lead times. And so there's no question, there's lessons learned. And that really is reflective of my comment of the intense focus on the look-forward that we hope is going to drive improved results in '24 and beyond.
Stuart Miller, Executive Chairman
I feel that your question really is, have we altered some of the landscapes in the way that we stockpile parts and programs? I think that there are definitely things that we have seen and learned as we've gone through the challenges of the supply chain. I think that Rick and Jon together have been working with our trade partners to think about how we prevent those same kinds of log jams or bottlenecks from taking place again. And that's an evolving picture. Can we point to specifics right now? Probably not as much as you'd like us to, but it is something that we're focused on.
Susan Maklari, Analyst
Okay. That's very helpful color. And then I guess staying on the topic of cash generation, when you think about Diane's comments to Ken's question around free cash flow conversion, it implies that you're going to have really some very impressive levels of cash. How do you think about the allocation of that capital? You bought back some stock this quarter. You paid down debt. But long term, how are you thinking about the shareholder return piece of that? And where that sort of fits relative to where we are today?
Stuart Miller, Executive Chairman
Yes. Great question. We're very focused on that. As you can imagine, we do see increased cash flow accumulating. And Diane won't let me tell you to what extent, but it's greater than where we are right now, and that sets up opportunity. Capital allocation has become a very strategic part of our thinking process. We consider regularly the relationship between debt retirement and stock buyback. For now, we are taking an opportunistic view of stock buyback in that we have basically been focused on a steady-state level of repurchase, but that could grow over time as we look opportunistically. And we are also looking at other strategic possibilities that will reveal over time. We're not asleep at the switch. We recognize that the accumulation of cash is a bit unusual within the industry. We're not uncomfortable with it, and we're being very thoughtful about it. That will evolve over time.
Susan Maklari, Analyst
Okay. Thank you for all the color and good luck.
Operator, Operator
Next, we'll go to the line of Stephen Kim from Evercore ISI. Please go ahead.
Stephen Kim, Analyst
My first question is going to also focus a little bit on the balance sheet side. And I guess, specifically, in the wake of the regional bank trust, we're hearing that there's this window of opportunity that's opening up to maybe acquire some attractively positioned lots or even operations from some of the smaller, less well-capitalized builders, allowing builders such as yourself with a big war chest to accelerate market share gains. And I'm curious, could you weigh in on that? Are you seeing that as well? And if you are, can you take advantage of these kinds of opportunities while maintaining your asset-light program by utilizing your existing off-balance-sheet structures? Or is it reasonable to think your own lot count might move up a little bit before moving down again later? Or that you would need to create some other structures in order to accommodate it? If you can just give us some sense of how you're thinking about that relative to this window of opportunity that we're hearing about.
Stuart Miller, Executive Chairman
So Steve, these are key areas that we are closely monitoring. I believe we are still in the early stages regarding some of the questions and considerations. Many of these inquiries are more relevant to the land development sector, where developers outside of Lennar are definitely experiencing challenges. The cash reserves we have on hand present a strategic chance for us to get involved and ensure a steady flow from some of the participants, whether through partnerships or other arrangements. Regarding homebuilders, there is still funding available for those engaged in production. The situation could evolve over time, but we are well-positioned to seize the right opportunities as they arise. We have done this in the past and are willing to proceed. Your question about off-balance-sheet structures is very significant, as we are actively working on developing systemic solutions resembling an opco-propco configuration. Our efforts in this area can address some of the current market dysfunction. So the best response to your question is that all options are on the table. We are uniquely equipped to participate in these opportunities, which will focus on enhancing production consistency and growing our core manufacturing homebuilding business. Moving forward, our balance sheet gives us the flexibility to approach this in multiple ways.
Stephen Kim, Analyst
That's great. Yes, it's going to be interesting to watch. With respect to your income statement, you gave a 3Q order guide, which we appreciate. And it suggests an absorption rate, sales per community per month above what you achieved in the heyday of 2021 or post-pandemic period, it appears. And I'm curious, are absorption rates benefiting from a sort of mix shift of community types, such as maybe more communities with attached product or larger communities or something like that? And if so, if there is this kind of mix shift that's happening behind the scenes, can you give us a sense for how much further this mix shift can go in a positive direction?
Stuart Miller, Executive Chairman
Rick, why don't you take that? And then, Jon.
Rick Beckwitt, Co-CEO and Co-President
So I would tell you that the pace that we're looking at going forward, particularly with regard to Q3, is really a reflection of the strategy that we all have implemented regarding starts. And as we said, we are going to run a production machine. Jon, Stuart, and I have really laid out work with our regional teams and division team to develop that community-by-community start base. We are benefiting a bit by some lower entry-level communities in a few markets. But over and above, what it really gets down to is a very disciplined, carefully managed stretch program. And that's why we're comfortable in giving you the visibility that we've given.
Jon Jaffe, Co-CEO and President
Steve, I would add, as Rick is saying, it is really paying attention closely to matching sales to our start pace so we don't build up inventory. And it's not so much going to attach product; it's going to markets that allow us to have a higher sales pace because we're at a lower price point. Many of the Texas markets are a great example of that. We're really able to go down the price curve, but we're doing that in all of our markets, and that allows us to incrementally quarter-by-quarter to increase our sales pace.
Operator, Operator
And our next call comes from Truman Patterson from Wolfe Research. Please go ahead.
Truman Patterson, Analyst
I wanted to follow up on Steve's question regarding the orders guidance for the third quarter. This indicates that orders usually decline, but they're expected to increase sequentially. There are a few perspectives on this; clearly, your starts pace suggests that underlying demand remains strong and is unusually strengthening sequentially. Additionally, the solid starts pace you've mentioned and the available spec inventory may be capturing market share from traditional build-to-order builders, while private builder capabilities are currently more constrained due to bank tightening. I'm hoping you can help us explore this further.
Stuart Miller, Executive Chairman
I'm going to let Jon answer that, but before I do, I want to correct you, Truman. I'm in Dallas, so it is still morning here. So go ahead, Jon.
Jon Jaffe, Co-CEO and President
Truman, so if you look at our strategy, we really accelerated our starts in Q2, recognizing the market opportunity where the industry was pulling back. And given that we didn't have an inventory buildup because of our strategy, we felt there was an opportunity to be more aggressive with starts and take advantage of the lack of resale inventory as well as the lack of new sale inventory. So we feel comfortable that we'll be able to sell at an accelerated pace because we'll have the inventory when the marketplace in general is not providing that inventory with a backdrop of really healthy demand for housing. So that gives us confidence that we'll be able to continue to accelerate our sales pace, managing that start pace.
Truman Patterson, Analyst
Okay. Perfect. And then it seems like you all are getting the cost savings that you spoke about previously. But I wanted to follow up on the comment, further improvement in gross margin beyond the third quarter, depending on market conditions. But if we assume that conditions are just stable from here, would fourth quarter gross margins continue to increase just outside of normal field expense leverage on deliveries? Said another way, should you see incremental cost savings sequentially into the fourth quarter, while maybe some modest pricing benefit on an apples-to-apples basis flows through?
Stuart Miller, Executive Chairman
Yes. So we decidedly didn't give any broader thoughts on margin for our fourth quarter, recognizing that, number one, we're feeling some leveling. So we're giving you some guidance for our third quarter and some thoughts on production for year-end. I think that the market still has enough proving to do, and it's moving around enough to where we really don't want to go beyond what we've said, and that is depending on market conditions, and we're going to let them evolve. Certainly, yesterday, with the Fed chair pausing, but maybe it's not even a pause, I think there's a lot of wait and see in terms of where interest rates go and where the market goes and talks of recession and jobs. We're going to wait and see a little bit on that. But as we sit right now, what we've said is that we see our margins continuing to improve as we go through the year. We're not going to give a boundary as to what that actually means. Let's give it some time.
Truman Patterson, Analyst
If I could just follow up quickly.
Stuart Miller, Executive Chairman
Sure. Sure.
Truman Patterson, Analyst
The cost savings, should they just build into the fourth quarter, the cost savings that you've spoken about previously?
Stuart Miller, Executive Chairman
I think, again, this is something that we're going to wait and see a little bit and see how demand patterns continue forward. But our constructive relationship with our trade partners really enables us to maximize. What we have found in this past year is that commitment to the consistency and the predictability of volume is really working to everybody's benefit. And I would say that, again, not to get too far over our skis. As we look ahead, we continue to see consistency in the trajectory, but we will have to wait and see how they actually flow through.
Truman Patterson, Analyst
Perfect. I think we're seeing it in the results, and good luck in the coming quarters.
Stuart Miller, Executive Chairman
Thank you.
Operator, Operator
Our next question comes from Alan Ratner from Zelman & Associates. Please go ahead.
Alan Ratner, Analyst
Nice quarter. I do have a question on some of the more near-term demand drivers. But Stuart, you did kind of bring up AI in your prepared remarks. And I know you guys have always been at the forefront of innovation in housing. And frankly, you don't hear AI mentioned a lot when it comes to housing. So I'm just curious if you're able to share any specifics in terms of where you see AI impacting your business going forward? And any steps the company has taken to be at the forefront of that?
Stuart Miller, Executive Chairman
Yes. So Alan, I wanted to be very careful with the use of that catchphrase that seems to be incendiary relative to stock prices when people are using them. I don't want to get out over our skis, but I did want to daylight that. The machine that we described that we are engaging is really a data-driven approach to many components of our business. And I think that we've done a tremendous amount of work. If you look at our digital marketing program, you look at our dynamic pricing model, both of them, we've talked about for many, many quarters for years. And these are data-driven approaches to the way that we're engaging the customer acquisition componentry of our business. It's a very integrated set of systems that are dependent on feedback loops. And any time that you find a process that becomes data-driven and the data improves to the point that it's actually relevant, at some point, there are large learning models that can be helpful in enhancing productivity. These are the areas where we are leaning in. I mentioned that we brought on a strategic Chief Technology Officer in Scott Spradley. And all of this is a coordinated program of taking steps at a time to improve the ingestion of data, to use the data more constructively and then to bring it to its next level where we're actually driving productivity gains within our business. We'll have more to report. In the meantime, if you find yourself in Miami, come on by. We'll show you what we mean.
Alan Ratner, Analyst
Great. Looking forward to checking that out, and I appreciate the additional information there. Second, on the pricing side, would love to just drill an air a little bit. So volume has continued to come in ahead of initial expectations. Your closing guide for the year now is about 10% above where it was six months ago. You're expecting orders to be up sequentially, which understood is a function of your start pace. But you're probably not starting homes unless you think there's demand for them. Yet when I hear your pricing commentary, it seems a bit more muted than I would expect, frankly, as far as more stability as opposed to maybe some pricing power returning to the market. So I know you've always been very articulate about your belief in the housing shortage at affordable prices, which I think is the key distinction there. And I'm curious if your decision at this juncture to not be more aggressive raising price is a function of your views on perhaps if prices were to go up or reaccelerate that, that would kind of take demand out of the market? Or is it just more of a conservatism stance around wanting to take market share in this still kind of choppy environment right now?
Stuart Miller, Executive Chairman
That's an excellent question, and we all have insights to share on it. To begin with, we approach this matter with careful consideration every day. We recognize that there is a significant housing shortage at the affordable level, which is clearly expressed by mayors and governors nationally. While it may not be widely discussed on a national scale, the push for workforce housing is a pressing local need and has become a social priority. As we consider our role in this situation, we believe there is a gap that must be addressed. There is a clear demand, and instead of pushing prices up, our strategy is to increase the pace while maintaining price stability. This relationship between price and pace is something that Jon, Rick, Diane, and I frequently discuss. It's central to our operations. Fundamentally, we see that both national and local markets need more volume, and since the supply is limited, our emphasis is on pace rather than price, ensuring we maintain consistency and predictability in our progress while also managing our costs effectively. Rick? Jon? Please feel free to add.
Rick Beckwitt, Co-CEO and Co-President
Stuart, I think you answered it well. It's really that consistency and cadence between starts and the sales that really keeps our machine going, and it makes us incredibly efficient. We're very focused on keeping our products affordable. In many cases, that's working hand in hand with our mortgage company and our mortgage in determining what that mortgage payment needs to be in order for us to transact. So it's a very careful and methodical approach. And if prices move, they move, but we're going to start and deliver the number of homes that we've targeted on a community-by-community basis.
Jon Jaffe, Co-CEO and President
I would only add that if you think about our core strategy of being a production-first builder, we have consciously chosen not to limit production and drive pricing to maximize margins. We think we are a better company by being production first and managing sales pace to start pace that drives better returns, better cash flow that drives better returns. And that consistency that we all have spoken about really makes us a much more solid company. So it's a strategic decision that really is reflective in the way that you see our pricing.
Operator, Operator
Why don't we go ahead and take one more question? Our final question comes from Mike Rehaut from JPMorgan. Please go ahead.
Mike Rehaut, Analyst
I wanted to revisit the topic of third-quarter orders. I believe it’s important to highlight your approach and how it sets you apart from the market. My focus is on how your orders are influenced by your own pace and strategy. I’m curious if, given the recent expectation from many builders to revert to typical seasonality over the last month or so, you feel your strategy, which you mentioned during the first few weeks of June, is leading to market share gains. We have observed some sequential softening month-to-month, which is common. I’m looking to understand if your outlook for the third quarter and your approach to starts indicate an active increase in market share compared to the broader market trends.
Stuart Miller, Executive Chairman
Yes. So I think Jon laid this out a few minutes ago. And what we saw was that the appetite of the market favored ready-to-go inventory, shorter cycle closings, and that many were actually pulling back in that regard. And there are really multiple ways to think about this. Number one, the existing home market, which is generally a supplier of short-cycle ready-to-go inventory, is somewhat constrained in that regard. Number two, a number of the builders in the context of the sharp increase in interest rates pulled back. The banking questions have perhaps limited part of the productive machine of the new home market to actually build inventory. We felt that there was an opportunity for us to fill a void. So I guess the answer to your question, Mike, is I think that we do see an opportunity to pick up some of the market share, where the market is not positioned to have that ready-to-go production or inventory in place available to the market. And we'll have to wait and see in the third quarter if we're right or not. But I think we feel pretty confident that we know where the market is, we know where the strength is, and that's what we've solved for.
Jon Jaffe, Co-CEO and President
I would only add one point, Stuart. I think you covered it well. And that is remember, Mike, we have a lever that the resale market doesn't have. So it starts with the fact that there's record-low inventory in resale, as you know. But we can buy down mortgage rates where the resale market can't. So if we need to accelerate our sales pace when the market is giving us, we have that lever that we can pull that's at our disposal.
Mike Rehaut, Analyst
I appreciate the clarification. I'm curious about the current incentives and discounts as a percentage of sales. You've mentioned mortgage rate buy downs several times. Overall, how do the current buy downs and other incentives compare to last quarter? Also, what trends do you expect to see moving forward, especially if average selling prices remain steady? You've suggested that some consumers might be experiencing financial strain, and that the rate buy downs could help address that. I am looking for insight into how incentives and discounts have changed this year and your outlook on them going forward.
Stuart Miller, Executive Chairman
Okay. So Diane, why don't you go ahead and give some color on that? And we'll fill in.
Diane Bessette, Chief Financial Officer
Yes, Mike. In the first quarter, our incentives were at 10.2%, which then decreased to 8.4%. This reflects a noticeable sequential decline. This trend is related to our efforts to make homes affordable for buyers, aligning with the points discussed by Stuart, Jon, and Rick. Looking ahead for the rest of the year, our approach will involve adjusting prices and utilizing incentives to maintain affordability. We haven't provided specific guidance, but we did observe a downward trend from Q1 to Q2.
Stuart Miller, Executive Chairman
All right. Why don't we go ahead and leave it there. Mike, thank you for your questions. And I want to thank everybody for joining us. We're pretty enthusiastic about how our business is navigating sometimes turbulent waters. And we look forward to reporting in our third quarter how things have continued and progressed. Thank you for joining.
Operator, Operator
That concludes today's conference. Thank you all for participating. You may now disconnect your line, and please enjoy the rest of your day.