LENNAR CORP quarterly report, Q2 FY2011

Lennar Corporation — Q2 2011 Form 10-Q

Business context and reporting period. Homebuilder and operator of mortgage/title services and Rialto real estate investments. The quarter and six-month period ended May 31, 2011; comparisons are with the corresponding 2010 periods. Dollar figures below are in millions unless stated otherwise.

Financial performance and position

MetricQ2 2011Q2 2010Six months 2011Six months 2010
Total revenue$764.5$814.5$1,322.5$1,388.9
Net earnings attributable to Lennar$13.8$39.7$41.2$33.2
Basic and diluted EPS$0.07$0.21$0.22$0.18
Homebuilding gross margin on home sales19.4%20.6%19.6%20.0%
Homebuilding operating earnings$21.2$29.5$56.7$34.9
Financial Services operating earnings$2.5$13.7$3.7$12.8
Rialto operating earnings$22.7$14.7$45.7$13.7
  • Q2 revenue fell about 6%; Lennar-attributable earnings fell about 65%. For six months, revenue declined about 5%, while attributable earnings rose about 24%.
  • Six-month operating cash flow was $4.6, versus $274.7 in 2010. Cash used in investing was $95.6 and cash used in financing was $171.7; cash and cash equivalents decreased $262.7 to $1,131.5. The 2010 operating cash flow included a $323.7 tax refund.
  • At May 31, cash included $945.2 in Homebuilding, $116.7 in Financial Services and $69.6 in Rialto. Total assets were $8,699.2; total liabilities were $5,440.0 and total equity was $3,259.2.
  • Homebuilding debt was $3,104.3, down from $3,128.2 at November 30, 2010. Homebuilding debt-to-total-capital was 53.9%; net debt-to-total-capital was 44.9%, up from 42.4% at November 30, 2010. Rialto notes payable were $752.3 and Financial Services debt was $189.5.
  • Home deliveries were 2,682 in Q2 versus 2,912; new orders were 3,204 versus 3,207, and backlog was 2,470 homes ($633.7) versus 2,499 homes ($655.9) at May 2010. Reported sales incentives averaged $33,900 per home in Q2 versus $31,100.

Material changes and drivers

  • Lower home deliveries drove the Q2 home sales revenue decline; home sales revenue fell 6%, deliveries excluding unconsolidated entities fell 9%, and average delivered home price rose 2% to $245,000. Higher incentives weighed on gross margin.
  • Homebuilding results were mixed by region: East earnings improved, while Central and Houston remained profitable but weaker; West recorded an operating loss in Q2. Central’s six-month loss included $7.6 of costs to remedy liabilities of a previously acquired company.
  • Financial Services earnings declined with lower mortgage and title activity; mortgage originations were $652 in Q2 versus $781, and the capture rate among Lennar homebuyers was 79% versus 85%.
  • Rialto results benefited from loan interest income and gains associated with real estate acquired through foreclosure; six-month Rialto other income also included gains on sale of securities. Its operating earnings include substantial FDIC noncontrolling-interest earnings: $12.9 in Q2 and $24.8 for six months.
  • Six-month Homebuilding results included a $37.5 litigation settlement, $15.4 Lennar’s share of a joint-venture debt-extinguishment gain, $10.0 of previously deferred management fees, and $8.4 of valuation adjustments to unconsolidated-entity investments. These items make period comparisons less indicative of ongoing operating performance.

Outlook, risks and unusual items

  • Management described the housing market as challenging, citing tight credit, weak consumer confidence and slow sales, with little evidence of a spring selling season. It nevertheless said it believed Lennar was positioned for a profitable 2011 and highlighted strategic land investment, higher-margin communities, its “Everything’s Included” marketing platform and cost control.
  • Management said Q2 new orders were flat year over year; May orders were up more than 30%, while the prior two months were down about 11%. It expected more favorable comparisons after the federal homebuyer tax credit ended in May 2010. No numerical full-year earnings guidance was provided.
  • The company warned continued weak or deteriorating housing demand could cause pricing pressure, slower absorption and additional inventory, investment or option-deposit write-downs. Six-month valuation adjustments and write-offs were $26.6, compared with $16.2 a year earlier.
  • Homebuilding unconsolidated-venture net recourse exposure was $105.2; maximum exposure before partner reimbursement agreements was $162.3. The company noted potential guarantee obligations, including joint-and-several exposure if partners cannot reimburse it. A venture’s Heritage Fields debt maturity was extended to 2018 with a reduced balance and a limited guarantee from partners.
  • Rialto’s distressed-loan and real-estate valuations depend on estimates of collections, collateral values and market conditions. Loans receivable were $938.8, while Rialto REO rose to $530.7 from $258.1 at November 2010; $140.9 of loans were nonaccrual, with no allowance recorded against those loans based on collateral values.
  • Financial Services warehouse facilities totaled $325 of commitments; one $175 facility matured July 29, 2011, and management expected renewal. Mortgage loan-sale representations and warranties expose the company to possible repurchase claims; the recorded loan-origination liability was $10.0.
  • Warranty reserve was $91.2. Lennar had accrued $82.2 for confirmed and estimated Chinese-drywall issues; the net reserve for the issue was $14.0. About 970 affected homes had been identified, primarily in Florida, and further inspections could change estimates.
  • The company reversed $10.8 of deferred-tax-asset valuation allowance in the six-month period, but the remaining allowance was $598.7. Federal tax examinations covered fiscal years 2005–2010; outcomes were not determinable.

Investor verification priorities

  • Assess how much reported earnings depended on the litigation settlement, foreclosure-related gains, joint-venture debt gain, deferred fees and tax allowance reversal.
  • Verify subsequent home orders, cancellations, backlog conversion, sales incentives and homebuilding margins against management’s 2011 profitability outlook.
  • Review cash generation, debt maturities and refinancing capacity, including renewal of the July 2011 Financial Services warehouse facility.
  • Monitor Rialto loan collections, nonaccrual balances, REO disposition values and the assumptions behind fair-value estimates.
  • Track joint-venture guarantee exposure, collateral adequacy, Chinese-drywall claims, mortgage repurchase requests and tax examination developments.