Stuart Miller
Executive Chairman at Lennar
Thank you and good morning, everyone. Thank you for joining us this morning. I'm here in Miami and joined by Rick Beckwitt, our Co-CEO and Co-President; Jon Jaffe, Co-CEO and Co-President; Diane Bessette, our Chief Financial Officer; David Collins, who you just heard from, our Controller and Vice President; and Bruce Gross, our CEO of Lennar Financial Services. There are other executives here with us as well. As usual, I'm going to give a macro and strategic overview of the company. After my introductory remarks, Rick is going to walk through our markets around the country and comment on our land strategy. And then Jon is going to update construction costs, supply chain, and cycle times.
As usual, Diane will give additional financial highlights and will give some rough boundaries, not guidance, just boundaries, given volatility in the market for the second quarter to assist in forward thinking and modeling. And then we'll answer as many questions as we can, and as usual, please limit yourself to one question and one follow-up so that we can include as many as possible.
So, let me go ahead and begin by saying that we're pleased to report that the Lennar team has produced strong and consistent results for the first quarter of what is shaping up to be a complicated and volatile 2023. The quarter started in December with traffic and sales stalled moving only with incentives and price adjustments. We entered January with interest rates declining and energized customer and improving margins, and then closed out February with rates again rising and challenging consumer confidence, although sales remained relatively strong at adjusted prices traffic was slowing. Of course, the quarter ended and the past couple of weeks have added new issues and questions that are reflective of a market that is looking for a bottom and looking for stability. With the Federal Reserve and federal government trying to reconcile the unintended consequences from aggressive interest rate hikes in order to curb inflation, there is simply no way to see around corners and anticipate with certainty what comes next. This is exactly the kind of volatility that our core operating strategy of maintaining volume using incentives and sales price has been built to endure. With volume and production as our constant and margin as our shock absorber, we managed with certainty to volatility and stay focused on our mission. If market conditions deteriorate, we compromise margin through price and/or incentives, but we generate strong cash flow. If conditions improve, we improve margins and bottom-line while also generating strong cash flow. Our primary focus is on cash flow.
We maintain our volume to move through the limited legacy land that we have, which is at legacy prices, whilst keeping our production machine working efficiently and rationalizing costs. And the fact that we're projecting a flattish number of deliveries in 2023 versus 2022 displays the strength of our strategy. Interest rates have continued to be the primary headwind to sales activity as inflation concerns have dominated the Federal Reserves' actions to date. At the same time, the housing supply shortage, especially workforce housing, discussed by every mayor and every governor across the country continues to drive customers to stretch their wallet as incentives and price reductions have worked to meet purchasers halfway. Additionally, interest rates have also sidelined the professional or institutional purchasers. Higher capital costs, together with higher capitalization rates, have made the purchase of single-family for rent homes less financially attractive as well. With that said, we still believe that housing -- that the housing market is beginning to find a point of stabilization and customers, both primary and institutional, are coming to grips with the new normal of higher but acceptable interest rates. The sudden sticker shock of rapidly rising interest rates in 2022 has mellowed, and while net prices are lower, incentives are moderating, cancellations have been normalizing lower, and margins have been bottoming as cost reductions are beginning to provide an offset.
As I've said many times in the past, the overall housing shortage remains the dominant theme and is defined by a decade-long production deficit in the country after the Great Recession. This deficit will be exacerbated by a growing reduction in housing starts of both single-family and multi-family homes brought on by the current housing recession. This shortage should be a stabilizing factor for the housing market over time.
Against this backdrop, we've remained steadfast in our adherence to the strategies we adopted as the Fed began its tightening program approximately one year ago. As noted, we've continued to focus on selling homes at market-clearing prices while building a consistent pace to meet the needs of the supply constraint housing market. Whether for purchase or for rent, housing shortages are a major concern across the country, as I've said, particularly at state and local levels. In spite of higher interest rates, driving affordability concerns, more dwellings are needed, and our mission is to meet that need. In the first quarter, we saw our margins fall to 21.2%, reflecting sales from prior quarters and adjustments to backlog. While margins fell 360 basis points over the prior quarter and 570 basis points year-over-year, they reflected the use of price reductions and incentives, that is closing cost payments and interest rate buydowns, to offset volatile interest rate and market shifts. We use these tools both to sell homes as well as to protect our backlog by adjusting pricing and incentives to ensure closings.
Our first quarter cancellation rate improved to 21.5%. While this is higher than the 10.2% last year, it is decidedly lower than the 26% last quarter and has been falling in each consecutive month. While our new orders were down from 10% year-over-year, that results has compared favorably to reported market conditions and enabled us to maintain a strong start pace that enables us to increase our expected closings for the year to a range of 62,000 to 66,000 homes delivered. On a positive note, very limited new-home inventory exists. Limited existing homes supply exists as existing homeowners hold onto extremely low mortgage rates and very limited multi-family production, combined with the chronic housing production shortfall over the past decade and leads the industry in the middle of what we believe will be a fairly short duration correction without an inventory overhang to resolve. These factors will also extend the runway for longer-term housing growth as the correction develops. We derived growing confidence in our ability to achieve sales at the best possible prices from our significant investment in digital marketing, which is more relevant than ever before. We have used our dynamic pricing model in conjunction with our formidable and improving digital marketing platform to continue to drive sales volume at market-clearing prices in order to maintain consistent production levels. Our proprietary digits platform, which we built on a Microsoft backbone, provides digital marketing insights and analytics that guide us to better execution while maximizing pricing using our dynamic pricing model. Our digital marketing team and our dynamic pricing team are getting better and better each quarter, and they enable us to refine and improve our execution and effectiveness as we accumulate more data and more experience.
Our second strategy was to work with our trade partners to rightsize our construction -- our cost structure to current market conditions while we reestablished cycle time at pre-supply chain crisis levels. Jon will cover this in great detail shortly, but at a high level, we continue to make meaningful progress with our trade partners as they appreciate our long-term strategy of maintaining consistent production. Relative to construction costs, Lennar led the way with reducing -- with a reduction in margin while maintaining volume and increasing market share as the market has corrected. As our margins have now contracted, we are driving cost-reduction participation from our trade partners. Our trade partners are working side by side with us to reduce costs and to keep the production machine working. While there continues to be a lag in those reductions coming through our reported numbers, in the back half of the year, cost reductions will improve lagging margins.
Cycle time reductions will also come through in the back half of the year. While cycle time has increased slightly this quarter from 211 days to 219 days last quarter, this timing reflects homes that had been in production for almost eight months. While we reviewed the front end of construction for homes that have started more recently, we are seeing a two-week reduction already coming through and we know that will improve over the next quarters. Improved cycle time will improve our inventory churn, which now stands at 1.2 and will help reduce inventory as we'll be able to carry less inventory to hit our deliveries and accordingly, we will improve our return on inventory as well.
Our third articulated strategy was to sharpen our attention on land and land acquisitions. While Rick will give detail on our land strategy, this has been a specific concentrated area of focus for all three of us: myself, Rick, and Jon, across the platform. We recognized early that land would be expensive relative to reduced prices and we therefore stopped the bleeding early. While we reconsidered every land deal in our pipeline, we have walked from deposits or renegotiated terms and price and we have been relentless in focusing on protecting cash and only purchasing the next strong margins at today's market pricing. We purchased very little land this quarter as we await better pricing that is more in line with current home sale prices. New land purchases in time will improve lagging margins. Fortunately, we're well-positioned with well-structured contracts and shorter-term deal structures that enable our capital allocation to be managed constructively. As with our trade partners, our land partners or sellers understand that we are maintaining volume and increasing market share while taking the first hit to our own margin. They will need to work together with us in cost reductions given lower home sales prices where we'll just have to move on.
Our fourth playbook strategy was to manage our operating costs, our SG&A, so that even at lower gross margins, we will drive a strong net margin. We've been driving our SG&A down over the past years quarter by quarter to new record lows and many of those changes, though not all, are hardwired into permanent efficiencies in operations. In our first quarter, we were able to marginally improve SG&A to 7.4% from 7.5% last year. And we believe if we continue to drive volume, we'll be able to limit increases and manage to advantageous cost levels. Nevertheless, as average sales prices come down, the percentages won't hold without corresponding additional cuts. We also note that at more difficult times, there will be upward pressure on some of our sales and marketing and realtor costs in order to drive and find purchasers and drive new sales. In this regard, the earlier discussion of our intense focus on our digital marketing platform is critically important in offsetting many of these potential cost increases.
Our fifth playbook strategy is to maintain tight inventory control. This is exactly what drives cash flow and our cash flow machines and we're focusing on this part of our business every day. Both land and home inventory control are core focus of our overall business and leadership team. And in our first quarter numbers, you can see our focus on these elements in our 14.2% percent debt-to-total capitalization rate, which is down 410 basis points from last year's 18.3%, and our $4.1 billion cash position together with our $2.6 billion undrawn revolver, which together provides excellent liquidity and flexibility. Tight control of land and completed home inventory has enabled cash flow so that our net debt-to-total-capital is actually negative at this point.
Inventory management is the most carefully reviewed and managed part of our business and enables us to maintain an extremely low inventory of completed, not sold, homes which are consistently -- which have been consistently been at or under one home per community for the past years. And right now, we have approximately 1,300 unsold and completed homes. We're well aware the inventory has remained flat as opposed to lower year-over-year as one might expect because of the expanded cycle times due to the supply chain disruption. We also know that this inefficiency will correct over the next few quarters and will return approximately $1.5 billion of inventory and turn it into additional cash. Additionally, a pause in growth this year will reduce the inventory and generate additional cash over the next year as well.
The fixed strategy is to continue to focus on cash flow and bottom-line in order to protect and enhance our already extraordinary balance sheet. With our balance sheet strong, we're able to complement our strong operational executions with stock repurchases and debt reductions that improve total shareholder returns and return on equity. As we continue to execute our strategies, we will continue to drive strong cash flow and bottom-line profitability, and even though bottom-line profitability will be compressed year-over-year, as prices and margins are impacted in a correcting market, our balance sheet and our cash position will continue to improve. This improvement enables the flexibility to be opportunistic as market conditions stabilize.
Finally, we have added an additional strategy -- an additional core strategy since last quarter end. This is the strategy of continuous improvement focus throughout the company. Although it seems obvious and perhaps a little trite, we have created a central focus on continuous improvement metrics for every leader in our company with a direct tie to performance measurement and bonus structure. Last year, we recruited a new CHRO with specific expertise in this area and we developed a determined and constructive program of engagement and measurement across our platform. Welcome aboard, Drew Holler. Now that he has been with us for about six months, I wanted to formally welcome Drew to the company on our earnings call and let him know formally that we, meaning me, Rick, Jon, and all of our shareholders, expect really exciting improvements that will help Lennar continue to reach higher and drive harder to be the best version of ourselves.
So, in conclusion, it seems that the homebuilding industry has been skating on a very thin edge between some very strong headwinds and some equally strong tailwinds that have required careful navigation and refined adjustments along the way. The headwinds have been defined by Federal Reserve-driven interest rate increases, driven by stubbornly high inflation. The consumer has attempted to adjust. The tailwinds have been defined by housing shortages across the country as well as production deficits over the past decade. And while the consumer remains challenged by affordability concerns, they're adjusting to the new normal of higher interest rates and asking to purchase their homes.
In these extraordinarily difficult and volatile market conditions, the Lennar team has focused on strategy and we have executed with precision. We ended the first quarter was stronger-than-expected revenues and closings, strong profitability, and cash flow, a fortified balance sheet, and strong liquidity. We have a plan of execution to continue to navigate the uncertainties of 2023 with a focus on maintaining volumes, maximizing margins, managing inventories, driving cash flow, managing land and land spend, and further enhancing our balance sheet in spite of the challenging market conditions. Accordingly, we're not guiding but giving some broad boundaries for our second quarter closings to between 15,000 and 16,000 homes with a gross margin we expect between 21% and 21.5%. Additionally, we're targeting delivery volume for the full year to be between 62,000 and 66,000 homes as we drive volume and pick up market share and build margins back up to reconciliation of construction and land costs while carefully managing SG&A. While we're prepared for volatility and adversity along the way, we will stick to our focus on our core operating strategies in order to perform as expected. Simply put, that's what we expect of ourselves, and we hope in the process, we will continue to earn your trust and respect.
Thank you. And with that, let me turn over to Rick, who's going to walk through a review of our market conditions across the platform.
