Lennar Corporation — Q2 2015 Form 10-Q
Business context and period. Lennar is a homebuilder with Financial Services, Rialto real-estate finance and investment, and Multifamily operations. This unaudited report covers the quarter and six months ended May 31, 2015; comparisons are with the same 2014 periods unless noted.
Financial and operating highlights
- Revenue and earnings: Q2 revenue was $2.393 billion, up 32%; net earnings attributable to Lennar were $183.0 million, up 33%. Diluted EPS was $0.79 versus $0.61; basic EPS was $0.89 versus $0.67. For six months, revenue was $4.037 billion and net earnings attributable to Lennar were $298.0 million, compared with $3.182 billion and $215.8 million, respectively.
- Homebuilding: Q2 home-sale revenue rose 30% to $2.1 billion as deliveries increased 20% to 5,989 and average delivered price increased 8% to $348,000. Home-sale gross margin declined to 23.8% from 25.5%; selling, general and administrative expense improved to 10.0% of home-sale revenue from 10.8%. Six-month home-sale gross margin was 23.5% versus 25.3%.
- Demand and backlog: Q2 net new orders increased to 7,271 homes from 6,183. At May 31, backlog was 8,073 homes valued at $2.889 billion, versus 6,858 homes and $2.350 billion a year earlier. Active communities increased to 667 from 579.
- Other segments: Q2 Financial Services operating earnings rose to $39.1 million from $18.3 million; mortgage capture rate on Lennar buyers was 82% versus 77%. Rialto reported $6.9 million of segment operating earnings, while Multifamily reported an $8.7 million operating loss. Six-month Multifamily operating loss was $14.4 million.
- Cash flow and liquidity: Six-month operating cash flow was negative $994.5 million, compared with negative $721.7 million, primarily reflecting inventory investment and growth in Rialto and Financial Services loans held for sale. Investing cash flow was negative $7.3 million; financing cash flow was positive $640.2 million. Cash and cash equivalents were $920.2 million at May 31, down from $1.282 billion at November 30, 2014.
- Debt and capital: Homebuilding debt was $5.291 billion, up from $4.690 billion at November 30, 2014. Homebuilding debt-to-total-capital was 50.7%; net debt-to-total-capital was 47.5%. The company reported compliance with credit covenants, including a 50.7% leverage ratio against a 65% maximum and liquidity coverage of 2.30 against a 1.00 minimum.
- Balance sheet: Total assets were $13.895 billion and total liabilities were $8.420 billion at May 31, 2015. Inventory totaled $8.754 billion, up from $7.737 billion at November 30, 2014.
Material changes versus prior period
- Higher deliveries, selling prices and active communities drove homebuilding revenue and earnings growth, but rising land and construction costs contributed to lower home-sale gross margin percentages.
- Financial Services earnings increased with higher mortgage origination volume, including refinance and purchase business, and a higher capture rate.
- Rialto’s loan impairments fell materially year over year, but equity earnings from unconsolidated entities and gains on real-estate-owned property sales were lower.
- Debt rose following note issuance and revolving-credit borrowings. Lennar issued $500 million of 4.75% notes due 2025 and used proceeds with cash to retire $500 million of 5.60% notes due 2015; it also issued $250 million more of 4.50% notes due 2019.
- Homebuilding equity earnings included significant El Toro venture gains: $11.6 million in Q2 and $43.0 million for the six months. The six-month amount includes gains from homesite and commercial-property sales; a related $44.6 million gross profit on homesites sold by El Toro to Lennar was deferred.
Outlook, risks and contingencies
- Management described a slow, steady, multi-year housing recovery and said it expects Lennar to achieve another year of increased profitability in fiscal 2015. It expects homebuilding and Financial Services to remain the principal earnings drivers.
- Management expects some homebuilding margin contraction versus the prior year as costs outpace selling-price increases, competitive pressures persist and previously inactive land is developed. It plans continued selective strategic land investment.
- Management cited constrained housing supply and mortgage access, competition from existing and foreclosed homes, and Houston demand weakness in higher-end homes amid energy-sector volatility. Other stated risks include housing-market deterioration, interest-rate and credit-market changes, cost inflation, inventory impairments, joint-venture obligations and refinancing or covenant risks.
- Multifamily had interests in 26 communities: two completed and operating, six partially completed and leasing, and 18 under construction. Management cited a $4.5 billion potential-project pipeline and continued rental-market opportunity, while noting the need to execute development and eventual property sales.
- Maryland litigation: A court ordered Lennar to purchase a property for the remaining $114 million contract price and pay interest, taxes and attorneys’ fees. On June 29, 2015, the court set simple interest at 12% per year—about $13.7 million annually and approximately $96 million accrued as of May 31, 2015—and allowed a stay during appeal upon posting a $223.4 million bond. Lennar plans to appeal, disputes the decision, and recorded no liability because it did not consider a loss probable.
- Management noted variability in quarterly results and that interim results are not necessarily indicative of full-year results. It reported no material changes to the risk factors in its latest Form 10-K.
Important facts for investors to verify
- Whether backlog converts to closings at expected prices and cancellation rates, particularly given the 15% Q2 cancellation rate and regional variation.
- Whether homebuilding gross margins stabilize as land and construction costs rise and incentives change.
- How inventory growth and negative operating cash flow evolve as land investment and loan-held-for-sale balances change.
- The outcome and potential financial exposure of the Maryland litigation, including the appeal, interest, taxes, attorneys’ fees and bond requirement.
- Debt levels, covenant headroom, warehouse-facility renewals, and the dilution or cash effects of the subsequent exchange of approximately $106 million of convertible notes for cash and shares.