Lennar Corporation — Q1 2011 Form 10-Q
Reporting period: Three months ended February 28, 2011. Unless stated otherwise, amounts below are in U.S. dollars; financial statement figures have been converted from thousands to millions.
Business context and reporting period
Lennar operates homebuilding businesses across U.S. regions, mortgage and title services through Lennar Financial Services, and distressed real-estate investing through Rialto Investments. The filing is an unaudited quarterly report; management cautions that quarterly results are variable and are not necessarily indicative of full-year results.
Financial and operating performance
- Revenue: $558.0 million, down 2.9% from $574.4 million. Homebuilding revenue was $466.7 million, down 10.4%; Financial Services revenue was $57.7 million, up from $53.4 million; Rialto revenue was $33.6 million, compared with $0.3 million.
- Profit: Earnings attributable to Lennar were $27.4 million, or $0.14 diluted EPS, versus a $6.5 million loss, or $0.04 diluted loss per share. Earnings before taxes were $36.3 million versus a $19.0 million loss. Net earnings including noncontrolling interests were $38.7 million.
- Homebuilding margin: Home-sale gross margin was $91.7 million, or 20.0% of home-sale revenue, versus $98.4 million, or 19.2%. Lower sales incentives as a proportion of revenue helped improve the percentage margin. Incentives averaged $33,100 per delivered home versus $37,100.
- Cash flow and liquidity: Operating cash flow was $9.7 million, down from $89.4 million. Investing used $2.1 million, versus $424.1 million used in the prior-year quarter; financing used $195.1 million. Cash and cash equivalents ended at $1.207 billion, compared with $913.2 million at February 28, 2010; homebuilding cash was $1.014 billion, down from $1.207 billion at November 30, 2010.
- Debt and leverage: Lennar Homebuilding debt was $3.129 billion. Its debt-to-total-capital ratio was 54.2%, versus 52.4% a year earlier; net debt-to-total-capital was 44.5%, unchanged from a year earlier. Homebuilding average debt was $3.1 billion, with a 5.7% average incurred rate. Rialto notes payable were $752.3 million; Financial Services warehouse borrowings were $122.3 million.
- Balance sheet: Total assets were $8.580 billion and total liabilities $5.347 billion at February 28, 2011. Total equity was $3.233 billion. Homebuilding inventory was $4.297 billion.
- Homebuilding demand: Lennar reported 1,903 deliveries excluding unconsolidated entities, down from 1,988, and an average delivered price of $240,000 versus $258,000. Net new orders were 2,267 homes, down 12% from 2,577; backlog was 1,948 homes worth $497.5 million, versus 2,204 homes worth $581.5 million. The cancellation rate rose to 17% from 13%.
Material changes versus the prior comparable period
- Lennar returned to attributable profitability, while total revenue declined modestly and homebuilding revenue and deliveries decreased. Management attributed weaker demand in several markets partly to the absence of the federal homebuyer tax credit.
- Rialto reported $23.0 million of operating earnings, including $12.0 million attributable to noncontrolling interests, compared with a $1.0 million operating loss. Financial Services also moved to operating earnings of $1.2 million from a $0.9 million loss.
- Homebuilding earnings benefited from a $37.5 million litigation settlement and a $15.4 million share of an unconsolidated venture’s debt-extinguishment gain; the company also recognized $10.0 million of previously deferred management fee income. The settlement was reflected across reported income and expense items.
- Operating cash flow fell from the prior-year quarter, which included a $93.8 million tax refund. Inventory increased by $81.1 million in operating cash flow, primarily due to strategic land purchases.
- Rialto real estate owned increased to $446.2 million from $258.1 million at November 30, 2010, including $175.9 million of real estate acquired in satisfaction of loans. Loans receivable declined to $1.026 billion from $1.219 billion.
Outlook, commentary, risks and unusual items
- Outlook: Management said the timing and extent of a housing recovery remained uncertain, and the spring selling season’s momentum was unclear. It nevertheless believed Lennar was positioned for a profitable fiscal 2011. Management emphasized margin preservation over sales volume, selective land acquisitions, and conservative underwriting for Rialto.
- Housing and asset valuation risks: Management said demand remained depressed or had weakened in many communities. Further market deterioration could increase pricing pressure, slow absorption, and lead to additional inventory, investment, or option-deposit write-downs. First-quarter valuation adjustments and write-offs totaled $22.5 million.
- Joint-venture exposure: Maximum recourse exposure on Lennar Homebuilding unconsolidated-entity debt was $178.7 million, or $121.5 million net of partner reimbursement agreements; this was up from $172.9 million maximum at November 30, 2010. A $36.3 million guarantee was provided in connection with an extension and partial debt reduction at Heritage Fields El Toro. The venture’s debt was reduced from $573.5 million to $481.0 million and extended to 2018.
- Rialto credit and valuation risk: Rialto’s acquired loan portfolios require estimates of future collections and collateral values. Nonaccrual loans had a carrying value of approximately $193.8 million and no recorded allowance; management said collateral value supported the carrying amount at quarter-end. Changes in recovery expectations could affect income and impairment provisions.
- Warranty and legal exposure: The warranty reserve was $104.0 million. Lennar had accrued $82.2 million for confirmed and estimated Chinese drywall claims, with $17.8 million remaining net of payments; inspections could identify additional affected homes. Mortgage loan sale representations and warranties may also result in repurchase claims, and management warned actual losses could exceed reserves.
- Funding and commitments: Financial Services’ warehouse facilities had $325 million of committed capacity; one $175 million facility matures in July 2011 and management expected renewal or replacement. Lennar had $710.0 million of performance and surety bonds, with $331.4 million of related costs to complete; it did not anticipate material draws. Management reported compliance with debt covenants at quarter-end.
- Taxes: Lennar reversed $8.5 million of its deferred-tax-asset valuation allowance during the quarter; $601.0 million remained. Tax examinations were ongoing, and the final outcome was not determinable. Management expected unrecognized tax benefits to decrease by $25.0 million within twelve months.
Important facts for investors to verify
- How much of Q1 profit came from the litigation settlement, debt-extinguishment gain, deferred management fee income, and Rialto foreclosure gains, and how sustainable are recurring earnings?
- Whether orders, cancellations, backlog, home prices, and regional gross margins improve or deteriorate in subsequent quarters.
- Whether operating cash generation strengthens while Lennar funds land purchases, joint ventures, and Rialto investments, and how reported cash is distributed among business segments and consolidated entities.
- Potential exposure from joint-venture guarantees, loan-portfolio recoveries, warranty claims, mortgage repurchases, and property valuation assumptions.
- Renewal or replacement of the Financial Services warehouse facility maturing in July 2011, and the company’s ability to manage upcoming debt obligations.