LENNAR CORP quarterly report, Q3 FY2013

Lennar Corporation — Q3 2013 Form 10-Q

Business context and period. Lennar is a homebuilder with Financial Services and Rialto Investments segments. This unaudited quarterly report covers the three and nine months ended August 31, 2013; balance-sheet comparisons are to November 30, 2012.

Financial results and position

Metric	Q3 2013	Q3 2012	Nine months 2013	Nine months 2012
Total revenue	$1.602 billion	$1.100 billion	$4.018 billion	$2.755 billion
Earnings before taxes	$189.4 million	$58.6 million	$405.0 million	$117.2 million
Net earnings attributable to Lennar	$120.7 million	$87.1 million	$315.6 million	$554.8 million
Diluted earnings per share	$0.54	$0.40	$1.42	$2.56

Homebuilding: Q3 homebuilding revenue was $1.462 billion, up from $955.8 million. Home-sales gross margin was 24.9%, versus 23.2%; selling, general and administrative expense was 10.2% of home-sales revenue, versus 12.0%. For the nine months, homebuilding revenue was $3.611 billion and home-sales gross margin was 24.0%, compared with $2.388 billion and 22.4% in 2012.
Housing activity: Q3 deliveries excluding unconsolidated entities increased 37% to 4,972; average delivered price rose 13% to $291,000. Net new orders were 4,785 homes, up from 4,198. Backlog grew 32% to 5,958 homes, valued at $1.919 billion, from 4,513 homes and $1.251 billion.
Segments: Q3 Financial Services operating earnings were $23.5 million, compared with $25.3 million; nine-month earnings increased to $68.8 million from $51.6 million. Rialto reported Q3 operating earnings of $0.7 million, versus a $5.7 million loss, and nine-month earnings of $10.6 million, versus $6.8 million.
Cash flow: Operating activities used $1.018 billion in the first nine months, compared with $490.5 million used in 2012, primarily reflecting inventory investment and Rialto loans held for sale. Investing activities provided $434.0 million; financing activities used $155.3 million. Cash and cash equivalents ended at $571.8 million, down from $1.311 billion at the start of the fiscal year.
Debt and liquidity: Lennar Homebuilding debt was $4.625 billion, up from $4.005 billion at November 30, 2012. Homebuilding debt-to-total-capital rose to 55.5% from 54.0%; net debt-to-total-capital rose to 53.0% from 45.6%. The company reported covenant compliance, a 57.6% leverage ratio against a 65% limit, and liquidity of 1.77 times the covenant requirement of 1.00. The $950 million revolving credit facility matures in June 2017, with $100 million drawn. Financial Services warehouse borrowings were $290.3 million; Rialto RMF warehouse borrowings were $133.1 million.
Balance sheet: Total assets were $11.016 billion, total liabilities $6.845 billion and total equity $4.171 billion at August 31, 2013.

Material changes versus prior period

Revenue and homebuilding profitability expanded with higher deliveries and selling prices, lower sales incentives, and operating leverage. Incentives averaged $18,700 per delivered home in Q3, versus $26,100 a year earlier.
Nine-month net earnings fell from 2012 despite stronger pretax earnings, mainly because 2012 results included a $447.0 million deferred-tax valuation-allowance reversal and a $416.6 million income-tax benefit. 2013 included an $83.1 million tax provision for the nine-month period.
Homebuilding debt increased and cash declined as Lennar invested in land and inventory and expanded financing activity. The company issued $275 million of 4.125% senior notes due 2018 and an additional $225 million of 4.750% notes due 2022; it also repaid $63.0 million of 5.95% notes due 2013.
Rialto revenue declined year over year, reflecting lower loan-portfolio interest income and the completion of the AB PPIP fund in 2012; higher realized gains on REO sales and lower loan impairments supported Q3 results.

Outlook, commentary and risks

Management said the housing market was in a solid recovery, while acknowledging possible moderation from higher mortgage rates and reduced federal stimulus. It expected substantial fiscal 2013 profitability, a slight Q4 increase in average delivered home prices, and Q4 gross-margin percentages to remain relatively flat. These are forward-looking statements, not guarantees.
Management cited constrained housing supply, limited entitled and developed land, improving mortgage-credit availability, and expected price increases to outpace cost increases. It also noted rising materials, labor and land costs and warned that moderate rate increases, if larger or more persistent, could affect demand.
Rialto launched Rialto Mortgage Finance (RMF) in Q3 to originate commercial mortgage loans. It had originated $245.2 million by August 31; in September, after quarter-end, it securitized $198 million. Management expects RMF to contribute meaningfully to Rialto revenue.
Key risks include housing-market or economic deterioration, mortgage availability and interest rates, competition, land and construction costs, inventory valuation, entitlement and financing delays, joint-venture partner performance, debt-covenant compliance, legal and environmental exposure, and tax-estimation uncertainty.
Contingencies include $671.5 million of performance and surety bonds, with approximately $435.7 million of related future site-improvement costs, and $338.6 million of letters of credit. Management did not anticipate material draws. Lennar reported $27.6 million of net recourse exposure to homebuilding unconsolidated entities; guarantees and partner reimbursement arrangements could create additional exposure.
The company had identified approximately 1,010 Florida homes with defective Chinese drywall and had accrued $82.2 million over time for related warranty costs; the remaining reserve, net of payments, was $1.8 million at August 31, 2013. Warranty reserves overall increased to $99.5 million from $84.8 million a year earlier.
Lennar revised certain prior-period supplemental consolidating disclosures and classifications; it stated the revisions did not affect consolidated financial statements. Management concluded disclosure controls were effective and reported no material change in internal control over financial reporting during the quarter.

Important facts for investors to verify

Whether higher prices and lower incentives can offset rising construction and land costs, particularly in weaker-margin regions.
Whether backlog converts into deliveries as expected, including the effect of cancellations, mortgage rates and lending standards.
Cash use, inventory growth and the increase in homebuilding leverage; review covenant headroom and upcoming debt maturities.
RMF’s post-quarter securitization, warehouse financing exposure and ability to sustain origination and fee revenue.
Unconsolidated-venture guarantees, commitments, letters of credit, bond obligations and potential claims, including drywall and mortgage-loan representations-and-warranties exposure.
The effect of deferred-tax asset realization assumptions and any outcomes from ongoing IRS and state tax examinations.