LENNAR CORP quarterly report, Q2 FY2016

Lennar Corporation — Q2 2016 Form 10-Q

Reporting period: Quarter and six months ended May 31, 2016. Lennar is a homebuilder with mortgage/title services, real estate investment and finance (Rialto), and multifamily development operations. Comparisons below are to the corresponding 2015 periods unless noted.

Financial and operating performance

Metric	Q2 2016	Q2 2015	Six months 2016	Six months 2015
Total revenue	$2.746 billion	$2.393 billion	$4.739 billion	$4.037 billion
Net earnings attributable to Lennar	$218.5 million	$183.0 million	$362.5 million	$298.0 million
Diluted EPS	$0.95	$0.79	$1.58	$1.30
Net cash used in operating activities	—	$(175.4) million	$(994.5) million

Q2 revenue rose 15% and Lennar-attributable earnings rose 19%. Homebuilding revenue increased 16% to $2.451 billion; deliveries were 6,724 homes and average selling price was $363,000. New orders increased 10% to 7,962; backlog was 9,014 homes, valued at $3.336 billion.
Home-sales gross margin declined to 23.1% from 23.8% in Q2 and to 23.0% from 23.5% for the six-month period, primarily as land costs increased. Q2 homebuilding operating margin was 13.9%, up 10 basis points year over year; SG&A was 9.3% of home-sales revenue, versus 10.0%.
For the six months, cash used in operations improved substantially year over year but remained negative, mainly reflecting inventory investment and lower accounts payable and other liabilities. Cash and cash equivalents were $815.5 million at May 31, versus $1.158 billion at November 30, 2015.
Homebuilding debt was $5.316 billion; homebuilding debt-to-total-capital was 46.5%, versus 47.1% at November 30, 2015. Net homebuilding debt-to-total-capital, a non-GAAP measure, was 43.5%, versus 42.2%. Total liabilities were $8.485 billion and total equity was $6.363 billion. Management reported compliance with credit covenants.

Material changes and unusual items

Homebuilding growth reflected higher deliveries and average selling prices. Houston remained weaker, with demand affected by energy-sector volatility; Houston cancellation rates were 21% in Q2 versus 24% a year earlier.
Rialto reported a Q2 operating loss of $18.1 million, including a $16.0 million write-off of uncollectible hospital-related receivables. Lower commercial-mortgage securitization volume and margins also reduced revenue.
Multifamily reported Q2 operating earnings of $14.9 million, compared with an $8.7 million loss, primarily due to its share of a joint-venture property-sale gain and a third-party land sale. The six-month comparison also benefited from joint-venture property-sale gains.
The homebuilding equity loss from unconsolidated entities included costs associated with the FivePoint combination. Lennar contributed interests in three strategic joint ventures to a newly formed FivePoint entity; preliminary fair-value allocations remain subject to a measurement period.
In March, Lennar issued $500 million of 4.75% notes due 2021 and used the proceeds to retire $250 million of 6.50% notes due 2016. Holders converted or exchanged all $234 million of 2.75% convertible notes due 2020; about $68 million of 3.25% convertible notes were converted during the period, with a further $137 million converted after quarter-end.

Outlook, risks and contingencies

Management expects a slow, steady, though potentially erratic, housing recovery, citing low housing inventory, pent-up demand, low interest rates and improving employment. It forecast fiscal 2016 deliveries of 26,500–27,000 homes and described expectations for another year of strong profits.
Management expected 2016 gross margins to be lower than 2015 as cost increases outpace selling-price gains, amid competitive pressures and development of some previously inactive land. Land and labor constraints, mortgage availability and higher rents may limit the pace of market growth.
The Settlers Crossing Maryland litigation remains on appeal. A 2015 court ruling ordered Lennar to buy the property for the remaining $114 million contract price, plus 12% simple interest, taxes and attorneys’ fees. Interest was approximately $109 million through May 31, 2016; real estate taxes were $1.6 million. Lennar recorded no liability, stating a loss was not considered probable. A $223.4 million bond was posted to stay the judgment during appeal.
Multifamily obligations include a $324.5 million remaining equity commitment to its venture and completion/cost-overrun guarantees; Lennar’s maximum exposure for unconsolidated VIEs was reported at $776.4 million, including commitments and specified guarantee/letter-of-credit exposure. Homebuilding joint-venture maximum recourse exposure was $40.9 million.
Outstanding letters of credit totaled $487.4 million and surety bonds $1.3 billion, including $223.4 million related to pending litigation. Management did not anticipate material draws. The company cited housing-market, land-cost, financing, interest-rate, joint-venture, construction, regulatory and litigation risks.
After quarter-end, Lennar amended its revolving credit facility, increasing maximum borrowings from $1.6 billion to $1.8 billion and extending the maturity of $1.3 billion of commitments to June 2020. One Financial Services warehouse facility was also extended.

Important facts for investors to verify

Whether delivery growth and new orders translate into closings while home-sale gross margins face land-cost pressure; monitor backlog, incentives and Houston demand.
The outcome and potential ultimate cost of the Settlers Crossing appeal, including interest accrual, taxes and attorneys’ fees.
Rialto’s recovery of the hospital receivable, securitization volumes and margins, and further loan or real-estate impairments.
Funding needs and contingent exposure from multifamily commitments, joint ventures, completion guarantees, letters of credit and surety bonds.
Cash generation, inventory investment, debt maturities and leverage. Cash flow and results are seasonal and management cautions that interim results are not necessarily indicative of full-year performance.