Lennar Corporation — Q2 2018 Form 10-Q
Reporting period: Quarter and six months ended May 31, 2018. All amounts are U.S. dollars. Lennar is a homebuilder with mortgage/title services, real-estate investment and multifamily operations. Comparisons with 2017 are affected by the February 12, 2018 acquisition of CalAtlantic; prior-year reported results do not include CalAtlantic.
Financial performance and position
- Q2 revenue: $5.459 billion, up 67% from $3.262 billion. Homebuilding revenue was $5.064 billion; Financial Services $232.1 million; Rialto $45.2 million; and Multifamily $117.7 million.
- Q2 earnings: Net earnings attributable to Lennar were $310.3 million, or $0.94 diluted EPS, versus $213.6 million and $0.89. Earnings before taxes were $390.8 million versus $309.6 million.
- Six-month results: Revenue was $8.440 billion versus $5.599 billion; net earnings attributable to Lennar were $446.5 million, or $1.52 diluted EPS, versus $251.7 million and $1.05.
- Homebuilding: Q2 deliveries rose to 12,095 from 7,710; average delivered selling price rose to $413,000 from $374,000. New orders were 14,440, up from 8,898, and backlog was 19,622 homes valued at $8.568 billion. Q2 sales incentives averaged $23,000 per delivery, or 5.3% of home-sales revenue.
- Margins: Q2 home-sales gross margin was 16.8%, including a $236.8 million CalAtlantic purchase-accounting write-up; excluding it, margin was 21.6%, versus 21.5% in Q2 2017. Six-month reported margin was 17.8%, or 21.6% excluding $291.9 million of purchase-accounting adjustments, versus 21.3% in 2017.
- Cash flow: Six-month operating cash flow was positive $34.4 million, compared with negative $159.8 million. Investing used $965.5 million, including the CalAtlantic acquisition; financing used $565.9 million. Cash and equivalents were $1.154 billion at May 31, down from $2.651 billion at November 30, 2017.
- Debt and liquidity: Homebuilding debt was $9.986 billion, up from $6.410 billion at November 30, 2017, largely reflecting CalAtlantic. Homebuilding debt-to-capital was 42.4%; net debt-to-capital was 40.0%, versus 34.4% at November 30. Lennar had $950 million drawn on its $2.6 billion revolving facility and reported compliance with covenants. Covenant calculations showed a 49.4% leverage ratio against a 65% maximum and liquidity of 2.85 against a 1.00 minimum.
- Equity and dividend: Total equity was $13.699 billion, versus $7.986 billion at November 30, reflecting mainly shares issued for CalAtlantic. Quarterly dividend was $0.04 per share.
Material changes and unusual items
- CalAtlantic was acquired for a stated purchase price of $6.232 billion, primarily in Lennar shares; the provisional allocation included $3.315 billion of Homebuilding goodwill. Purchase accounting, integration costs and acquisition-related debt significantly affect reported comparisons.
- CalAtlantic-related acquisition and integration costs were $23.9 million in Q2 and $128.1 million for the six months. Purchase-accounting adjustments on delivered CalAtlantic backlog and construction-in-progress homes reduced pretax earnings by $236.8 million in Q2 and $291.9 million year to date.
- The six-month tax provision included a non-cash $68.6 million deferred-tax-asset write-down following the Tax Cuts and Jobs Act. The reported six-month effective tax rate was 31.8%; excluding that charge, Lennar reported 21.4%.
- Six-month Homebuilding other income included a $164.9 million gain on the sale of an 80% interest in a strategic joint venture. The 2017 comparison included a $140 million litigation loss, making year-over-year earnings comparisons less representative.
- Rialto’s six-month revenue fell to $99.5 million from $150.0 million, while operating earnings were $16.1 million versus a $7.3 million operating loss. Multifamily operating earnings declined to $13.6 million from $25.7 million, partly reflecting lower gains on property sales.
Outlook, commentary and risks
- Management described housing conditions as resilient, citing strong demand and limited new-home supply, while noting rising interest rates, labor shortages, construction costs and international trade tensions.
- Management increased expected CalAtlantic synergies to $160 million for 2018 and a $380 million target for 2019. It expects margins to improve as synergies and CalAtlantic volume build, and expects to deliver 46,360 homes in fiscal 2018. Management’s first priority for expected later-year cash generation is debt reduction and lower leverage.
- Lennar is pursuing a return toward a pure-play homebuilding platform. It engaged Wells Fargo Securities and Deutsche Bank Securities to advise on strategic alternatives for Rialto; plans to move Rialto Mortgage Finance into Financial Services. No significant transaction agreement was reported.
- Risks identified include housing-market or economic weakness, higher mortgage rates and operating costs, land-value impairments, execution and timing of CalAtlantic synergies, access to land and credit, joint-venture commitments, natural disasters, and Rialto securitization and repositioning risks.
- Contingencies include a Clean Water Act matter at a California development, for which management expects sanctions it does not currently consider material, and an ongoing DOJ inquiry into prior FHA-loan underwriting and quality-control processes. The DOJ had not asserted damages or penalties as of the filing. Lennar also reported substantial letters of credit and $2.5 billion of surety bonds; it did not anticipate material draws.
Important facts for investors to verify
- Whether CalAtlantic integration delivers the updated $160 million and $380 million synergy targets, and how much integration cost remains.
- Underlying homebuilding margins after the temporary purchase-accounting charges, alongside construction-cost trends, incentives, orders, cancellations and backlog conversion.
- Debt repayment and leverage progress, including the impact of acquisition debt and near-term maturities. Subsequent to quarter-end, Lennar redeemed $250 million of 6.95% notes due 2018.
- Cash generation relative to inventory investment, acquisition spending and committed multifamily equity funding.
- Developments in the DOJ FHA-loan inquiry, California environmental matter, warranty reserves and joint-venture guarantees.
- Any change in Rialto strategic plans and the financial effect of a potential sale, restructuring or transfer of its businesses.