Business context and reporting period
Lennar Corporation filed this Form 10-K for the fiscal year ended November 30, 2012. Its businesses are homebuilding, mortgage and title services, and Rialto Investments, which invests in and manages distressed real estate assets. Management described the housing market as stabilizing and recovering. The financial statements received an unqualified audit opinion; management and the auditor reported effective internal control over financial reporting.
Financial and operating results
| Metric | FY2012 | FY2011 |
|---|---|---|
| Total revenue | $4.105 billion | $3.095 billion |
| Earnings before income taxes | $222.1 million | $98.0 million |
| Net earnings attributable to Lennar | $679.1 million | $92.2 million |
| Diluted earnings per share | $3.11 | $0.48 |
| Cash used in operating activities | $424.6 million | $259.1 million |
| Cash and cash equivalents, all operations | $1.311 billion | $1.164 billion |
| Total assets | $10.362 billion | $9.155 billion |
| Total equity | $4.001 billion | $3.304 billion |
- Earnings quality: FY2012 net earnings included a $435.2 million income-tax benefit, including a $491.5 million partial reversal of the deferred-tax-asset valuation allowance ($2.25 per diluted share). Pretax earnings were $222.1 million; reported net income therefore benefited substantially from a non-cash tax accounting adjustment.
- Homebuilding: Revenue was $3.581 billion, up from $2.675 billion. Home deliveries rose to 13,802 from 10,845; new orders increased 37% to 15,684. Year-end backlog increased 87% in value to $1.160 billion (4,053 homes). Average delivered home price was $255,000 versus $244,000; cancellations were 17% versus 19%.
- Home-sale gross margin improved to 22.7% from 19.9%; selling, general and administrative expenses declined to 12.6% of home-sale revenue from 14.7%. Homebuilding operating earnings were $253.1 million versus $109.0 million.
- Other segments: Financial Services operating earnings rose to $84.8 million from $20.7 million, reflecting higher mortgage and title volumes and margins. Rialto reported segment operating earnings of $11.6 million versus $63.5 million; management’s alternative figures including noncontrolling interests were $26.0 million versus $34.6 million.
- Cash flow and liquidity: Operating cash use increased, mainly reflecting higher inventories from strategic land purchases and more loans held for sale. Investing activities provided $245.3 million and financing activities provided $326.5 million. Lennar Homebuilding cash was $1.147 billion at year-end.
- Debt and leverage: Homebuilding debt was $4.005 billion, up from $3.363 billion; Rialto debt was $574.5 million and Financial Services debt was $458.0 million. Homebuilding debt-to-total-capital improved to 54.0% from 55.5%; net debt-to-total-capital was 45.6% versus 46.4%. The company reported no borrowings on its $500 million committed revolving credit facility (up to $525 million with an accordion), which matures in May 2015.
Material changes and unusual items
- Homebuilding results improved across most markets, supported by more deliveries, higher prices, reduced sales incentives and a larger proportion of deliveries from higher-margin communities. Total inventory increased to $5.072 billion from $4.361 billion.
- Homebuilding inventory valuation adjustments and option-cost write-offs fell to $15.6 million from $38.0 million. The company’s share of valuation adjustments at unconsolidated homebuilding ventures was $12.1 million, versus $8.9 million; homebuilding equity losses from unconsolidated entities narrowed to $26.7 million from $62.7 million.
- 2011 included unusual homebuilding income, including a $37.5 million litigation settlement and gains related to a joint-venture asset distribution. In 2012, homebuilding other income included a $15.0 million gain on sale of an operating property, partly offset by a $6.5 million pretax loss on repurchasing senior notes.
- Rialto’s AB PPIP fund wound down in 2012; Lennar received $83.5 million in liquidating distributions and will receive no further sub-advisory fees from that fund. Rialto’s second fund had a first closing after year-end with approximately $260 million of commitments, including Lennar’s $100 million commitment.
Outlook, risks and contingencies
Management expected the housing recovery to continue in 2013 and said it was on track for another year of substantial profitability. Priorities included improving homebuilding margins through higher prices and lower incentives, controlling costs, and making carefully underwritten land acquisitions. Management expected Financial Services to remain profitable despite a less robust refinancing market, and described 2013 as a transition and ramp-up year for Rialto’s Fund II.
- Recovery remains sensitive to mortgage availability, interest rates, employment, consumer confidence, resale and foreclosure competition, and home prices. Proposed mortgage rules and tighter lending standards could constrain qualified buyers.
- Higher materials and skilled-labor costs may pressure margins, particularly where contracted home prices cannot be changed. Further deterioration in housing or land markets could trigger additional inventory, joint-venture, loan or REO impairments; 2012 homebuilding inventory impairments totaled $15.6 million.
- Debt maturities, convertible-note put rights, and renewal or replacement of Financial Services warehouse facilities are financing risks. Warehouse facilities were scheduled to mature in February, July and November 2013; management expected renewal or replacement. The company reported covenant compliance and a 5.36x liquidity measure against a 1.00x minimum liquidity test.
- At year-end, Lennar had $312.2 million in letters of credit and $606.5 million in performance and surety bonds; management did not anticipate material draws. Net recourse exposure to homebuilding unconsolidated entities was $49.9 million (maximum exposure $66.7 million); no unpaid guarantee liabilities were accrued.
- Warranty and mortgage-loan repurchase exposure persists. The warranty reserve was $84.2 million; the remaining Chinese-drywall reserve, net of payments, was $2.9 million. The mortgage repurchase reserve was $7.3 million. Management did not expect ordinary-course litigation to have a material adverse effect.
- Realization of deferred tax assets depends on future taxable income. The company reported $467.6 million of net deferred tax assets and $452.4 million of tax-effected federal and state NOL carryforwards; $88.8 million of valuation allowance remained, primarily for state NOLs.
Important facts for investors to verify
- How much of reported earnings and future profitability depends on using deferred tax assets, and whether taxable income supports that use.
- Whether order growth and backlog convert into deliveries at the stated prices and margins, given cancellations, mortgage availability and resale competition.
- Whether inventory growth and strategic land purchases generate cash returns, especially in light of negative operating cash flow in 2012.
- Whether 2013 warehouse facilities are renewed or replaced and whether debt maturities, convertible-note put options and covenant headroom remain manageable.
- Rialto’s loan and REO valuations, impairment assumptions, Fund II capital requirements and investment performance; also monitor warranty and mortgage repurchase claims against reserves.