Lennar Corporation — Q3 2016 Form 10-Q
Business context and period. This report covers the quarter and nine months ended August 31, 2016. Lennar operates homebuilding businesses across U.S. regions and also provides mortgage and title services, real-estate investment and finance through Rialto, and multifamily development. Comparisons are with the same periods in 2015 unless noted.
Financial performance and condition
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Total revenue | $2,833.9 million | $2,491.7 million | $7,573.4 million | $6,528.4 million |
| Pre-tax earnings | $339.6 million | $320.7 million | $869.1 million | $777.1 million |
| Net earnings attributable to Lennar | $235.8 million | $223.3 million | $598.4 million | $521.3 million |
| Diluted EPS | $1.01 | $0.96 | $2.59 | $2.25 |
| Homebuilding gross margin on home sales | 22.6% | 24.1% | 22.8% | 23.7% |
- Revenue and earnings: Q3 revenue rose about 14% and Lennar-attributable earnings about 6%; nine-month revenue rose about 16% and attributable earnings about 15%.
- Homebuilding: Q3 home-sales revenue increased 11%, reflecting 7% more deliveries and a 3% higher average selling price ($362,000 versus $350,000). Nine-month home-sales revenue increased 16%, with deliveries up 10% and average selling price up 6%. Homebuilding operating earnings were $344.9 million in Q3 and $908.2 million year to date.
- Margins and incentives: Home-sales gross margin declined as land and construction costs rose. Q3 incentives averaged $22,500 per delivered home (5.9% of home-sales revenue), versus $20,700 (5.6%) a year earlier. Homebuilding selling, general and administrative expense improved to 9.3% of home-sales revenue in Q3 from 9.9%.
- Other segments: Financial Services operating earnings increased to $53.2 million in Q3 from $39.4 million, primarily on refinance volume and higher profit per transaction. Multifamily earned $2.6 million in Q3 and $29.8 million year to date, with results benefiting from property-sale gains. Rialto reported an operating loss of $0.1 million in Q3 and $16.5 million year to date; the nine-month result included a $16.0 million write-off of uncollectible hospital receivables and higher real-estate-owned impairments and expenses.
- Cash flow: Operating activities used $3.1 million in the first nine months, compared with $1,088.4 million used in 2015. Inventory growth of $892.2 million was a major cash use. Investing activities used $116.7 million and financing activities used $222.6 million. Cash and cash equivalents across the reported businesses were $816.1 million at August 31, versus $1,158.4 million at November 30, 2015.
- Debt and equity: Homebuilding senior notes and other debt were $4.921 billion, down from $5.025 billion at November 30, 2015. Homebuilding debt-to-total-capital was 42.9% and net debt-to-total-capital 39.9%, both lower than the comparable August 2015 ratios. Total liabilities were $8.236 billion; stockholders’ equity was $6.546 billion. The $913.0 million of Financial Services debt primarily funds mortgage loans and is secured by related loans and receivables.
- Liquidity and covenants: Lennar had $125 million drawn on its unsecured revolving credit facility, whose maximum commitment was increased to $1.8 billion. Management reported compliance with debt covenants; the disclosed credit-agreement liquidity test was 2.12 against a 1.00 minimum. Warehouse facilities support mortgage and commercial-loan origination and are generally non-recourse to Lennar.
Material changes versus prior periods
- Quarterly and year-to-date revenue and attributable earnings increased, but homebuilding gross margin percentages fell by 1.5 and 0.9 percentage points, respectively, largely due to higher land costs.
- Q3 new orders rose 8% to 7,018 homes, deliveries rose 7% to 6,779, and backlog increased to 9,253 homes from 8,250 a year earlier. Houston remained weaker: energy-sector volatility weighed on demand, and its Q3 cancellation rate was 27%.
- Homebuilding equity results from unconsolidated entities shifted to losses, principally due to FivePoint combination costs and losses at the new FivePoint venture; the prior-year periods included significant gains from home-site and property sales and debt extinguishment.
- Debt activity included issuance of $500 million of 4.75% notes due 2021 and retirement of $250 million of 6.50% notes. Holders converted all $234 million of 2.75% convertible notes for cash and shares and converted approximately $243 million of 3.25% convertible notes into shares, reducing debt while increasing share count.
- Multifamily expanded its venture commitments: total commitments were approximately $2.0 billion at August 31, with a further $250 million commitment announced afterward. Lennar’s remaining commitment was $321.2 million at quarter-end.
Outlook, commentary, risks and unusual items
- Management described the housing recovery as gradual and supported by low interest rates, employment and consumer confidence, but constrained by land and labor shortages and limits on buyer financing and disposable income.
- Lennar expected to deliver 26,500–27,000 homes in fiscal 2016. Management anticipated lower Q4 2016 gross margins than Q4 2015 as cost increases were expected to outpace selling-price increases and competition continued. It targeted top-line growth of 7%–10%, emphasizing margin, pricing and cash flow.
- Management identified homebuilding and Financial Services as the expected main earnings drivers. Results are seasonal and may vary materially between quarters; reported interim results are not necessarily indicative of full-year performance.
- On September 22, 2016, after quarter-end, Lennar agreed to acquire WCI Communities for stated consideration of $23.50 per share, expected to comprise cash and Lennar Class A stock. The deal remained subject to WCI stockholder approval and other conditions; WCI could solicit competing proposals through October 26, 2016.
- A Maryland property-purchase lawsuit remains on appeal. The trial court ordered a $114 million purchase plus 12% simple annual interest from May 2008; accrued interest was approximately $113 million at August 31, 2016, with $1.6 million in real-estate taxes also identified. Lennar recorded no liability, stating it did not believe a loss was probable, and had posted a $223.4 million bond to stay the judgment.
- Other exposures include $1.4 billion of surety bonds, $475.8 million of letters of credit, joint-venture debt guarantees and completion/cost-overrun obligations. Management did not expect material draws on bonds or letters of credit. Lennar also received EPA stormwater notices for Florida sites; any expected monetary sanctions were not considered material.
- Warranty reserves were $133.5 million at August 31, 2016. Lennar cautioned that changes in housing, land, labor, construction costs, interest rates, mortgage availability, joint-venture performance and real-estate values could affect results.
Important facts for investors to verify
- Whether Q4 deliveries meet management’s fiscal 2016 target and whether gross-margin pressure continues.
- Trends in orders, backlog, cancellation rates, incentives and Houston demand, as well as the cost and availability of land and labor.
- Cash generation relative to inventory investment, capital contributions to ventures and remaining Multifamily Venture commitments.
- Debt maturities, revolver availability, warehouse-facility renewals and covenant headroom; distinguish homebuilding debt from financing debt in Financial Services and Rialto.
- Progress and final terms of the WCI transaction, including stockholder approval, consideration mix and closing conditions.
- Developments in the Settlers Crossing appeal, potential interest and related costs, and any change in management’s assessment or recorded contingency.
- Future Rialto loan impairments and recoveries, FivePoint venture results, Multifamily property-sale gains, and any additional unusual or nonrecurring items.