Lennar Corporation — Q1 2014 Form 10-Q
Business context and period: Unaudited results for the three months ended February 28, 2014, compared with the three months ended February 28, 2013. Lennar operates homebuilding, mortgage and title services, Rialto real estate investment and finance, and multifamily development businesses. The quarter’s results are not necessarily indicative of the full year; homebuilding activity is seasonal.
Financial and operating highlights
- Revenue: $1.363 billion, up 38% from $990.2 million. Homebuilding revenue was $1.231 billion, up 42%; Financial Services revenue declined to $77.0 million from $95.9 million, while Rialto revenue rose to $47.0 million from $25.6 million.
- Earnings: Pretax earnings were $125.9 million, versus $53.3 million. Net earnings attributable to Lennar were $78.1 million, or $0.35 diluted per share, versus $57.5 million, or $0.26 per diluted share. The 2014 results included a $45.9 million tax provision; the prior-year period included a $3.6 million tax benefit, including a $25.1 million valuation-allowance reversal.
- Homebuilding: Home-sale gross margin rose to 25.1% from 22.1%. Home deliveries excluding unconsolidated entities increased 13% to 3,597; average delivered price rose 18% to $316,000. Sales incentives declined to $21,300 per home from $23,300. New orders increased 10% to 4,465 homes, and backlog increased 15% to 5,662 homes, valued at $1.938 billion, up 33%.
- Cash flow and liquidity: Operating activities used $394.6 million, compared with $321.5 million used a year earlier, primarily reflecting higher inventory from strategic land purchases and RMF loans held for sale. Investing activities provided $75.3 million; financing activities provided $223.1 million. Cash and cash equivalents totaled $874.3 million at quarter-end, down from $970.5 million at November 30, 2013.
- Debt and capital: Lennar Homebuilding debt was $4.665 billion, up from $4.194 billion at November 30, 2013; its debt-to-total-capital ratio was 52.3%, and net debt-to-total-capital was 48.5%. The company issued $500 million of 4.50% senior notes due 2019. Its $950 million revolving credit facility matures in June 2017. Management reported compliance with debt covenants; covenant liquidity was 2.48 times the required level of 1.00 times.
- Balance sheet: Total assets were $11.527 billion, total liabilities $6.826 billion, and total equity $4.701 billion. Homebuilding inventories were $7.147 billion, up from $6.601 billion at November 30, 2013.
Material changes versus prior period
- Homebuilding gains reflected more deliveries and higher prices, lower incentives, a greater share of deliveries from newer, higher-margin communities, and a $5.5 million insurance recovery. These benefits were partly offset by higher construction and land costs.
- Financial Services operating earnings fell to $4.5 million from $16.1 million, amid lower mortgage refinance volume and lower profit per mortgage transaction.
- Rialto operating earnings rose to $3.5 million from $1.4 million. Growth in RMF originations and securitizations contributed, while segment expenses increased, including costs related to RMF and loan impairments.
- Multifamily operating loss widened to $6.2 million from $3.5 million as the business continued to develop its platform. The company reported 15 multifamily communities, 11 under construction.
- Homebuilding debt-to-total-capital improved versus the prior-year quarter’s 56.2%, but increased from 50.2% at November 30, 2013. Operating cash use also increased year over year.
Outlook, risks and notable items
- Management expected to deliver 21,000–22,000 homes in fiscal 2014 at average gross margins of about 25%, and said it was on track for another profitable year. It identified homebuilding and Financial Services as expected principal earnings drivers.
- Management described housing as recovering, citing improving traffic and sales during the quarter, pent-up demand, and constrained housing and entitled-land supply. It also cited potential headwinds from mortgage-market constraints, interest-rate volatility, consumer confidence, and reduced investor purchases.
- Management highlighted exposure to local housing conditions, home prices and sales pace, construction and land costs, mortgage availability and interest rates, inventory write-downs, joint-venture counterparties and guarantees, and compliance with debt covenants. Actual results may differ from its outlook.
- Rialto originated $295.5 million of commercial mortgage loans and sold $253.0 million into securitizations during the quarter. After quarter-end, Rialto issued an additional $100 million of 7.00% senior notes due 2018.
- Unusual and judgment-sensitive items include the $5.5 million insurance recovery, land-sale profits, real estate and loan valuation estimates, and the differing tax effects between periods. Management identified 26 homebuilding communities with potential impairment indicators but recorded no related impairment in the quarter.
- Potential commitments and contingencies include $759.4 million of performance and surety bonds, with $341.9 million of anticipated costs to complete the related site improvements; $407.4 million of letters of credit; and guarantees and funding commitments involving joint ventures. Management did not anticipate material draws on bonds or letters of credit.
Important facts for investors to verify
- Whether fiscal 2014 delivery and gross-margin guidance remains achievable as construction, labor and land costs rise and mortgage conditions change.
- Backlog conversion, cancellation rates and sales incentives: the reported overall cancellation rate was 16%, versus 15% a year earlier.
- Cash use, inventory growth and the funding needs of strategic land purchases, RMF and multifamily projects.
- Debt maturities, refinancing needs, credit-facility covenant headroom, and the effect of additional Rialto borrowing.
- Whether Financial Services can offset lower refinance activity, and whether RMF and Rialto earnings are sustainable after impairments, expenses and noncontrolling interests.
- Exposure under joint-venture guarantees, completion and cost-overrun commitments, letters of credit, and performance bonds.