Lennar Corporation — Q1 FY2017 10-Q
Business context and period: Quarter ended February 28, 2017; comparisons are with the three months ended February 29, 2016, unless noted. Lennar operates homebuilding, mortgage/title services, Rialto real estate finance and investments, and multifamily development. The quarter includes WCI Communities from its February 10 acquisition date.
Financial and operating results
| Metric | Q1 FY2017 | Prior-year period / comparison |
|---|---|---|
| Total revenue | $2,337.4 million | $1,993.7 million, up 17% |
| Earnings before income taxes | $49.6 million | $201.7 million |
| Net earnings attributable to Lennar | $38.1 million; diluted EPS $0.16 | $144.1 million; diluted EPS $0.63 |
| Operating cash flow | $79.3 million provided | $215.9 million used |
| Cash and cash equivalents | $929.1 million at February 28 | $1,329.5 million at November 30, 2016 |
| Total assets / total liabilities | $16,230.1 million / $8,974.3 million | $15,361.8 million / $8,150.2 million at November 30, 2016 |
- Homebuilding: Revenue was $2,018.7 million, up 13%. Home deliveries were 5,453, up 13% on the reported measure; management also cited 5,433 deliveries excluding unconsolidated entities. New orders rose 12% to 6,483. Backlog increased 18% to 9,017 homes, valued at $3,526.0 million.
- Average selling price of delivered homes was approximately $366,000, broadly unchanged. Home-sales gross margin declined to 21.1% from 22.7%; incentives increased to $22,700 per delivery from $21,600. Management reported a 10.8% homebuilding operating margin.
- Homebuilding operating earnings were $71.3 million versus $220.6 million, including the litigation accrual described below. Homebuilding equity in unconsolidated entities was a loss of $11.5 million versus earnings of $3.0 million.
- Other segments: Financial Services operating earnings increased to $20.7 million from $14.9 million, primarily on title activity. Rialto reported an operating loss of $0.8 million versus earnings of $1.6 million; loan and real-estate-owned impairments weighed on results. Multifamily operating earnings rose to $19.2 million from $12.2 million, including its $26.0 million share of gains on two property sales by joint ventures.
- Cash flows: Investing activities used $766.1 million, principally reflecting $596.2 million net cash paid for WCI and contributions to unconsolidated entities. Financing activities provided $286.3 million, including proceeds from $600 million of senior notes and $250 million of revolver borrowings. Cash declined by $400.5 million during the quarter.
- Debt and liquidity: Homebuilding debt was $5,778.3 million, up from $4,576.0 million at November 30, 2016. Homebuilding debt-to-total-capital was 44.8%, versus 39.4% at November 30; net debt-to-total-capital was 42.0%, versus 33.4%. The company had $250 million drawn on its $1.8 billion revolving credit facility and said it was in compliance with covenants. Covenant calculations showed a 46.1% leverage ratio against a 65% maximum and liquidity of 2.45 times against a 1.00 minimum.
Material changes, outlook and risks
- WCI acquisition: Lennar paid approximately $642.6 million in cash for the Florida luxury homebuilder. The provisional allocation included $163.3 million of goodwill. WCI contributed $19.5 million of home-sales revenue and a $8.9 million pretax loss for the post-acquisition period, including about $11 million of transaction expenses. Lennar funded part of the purchase with its January issuance of $600 million of 4.125% senior notes due 2022 and assumed WCI’s 6.875% notes due 2021.
- Litigation accrual: Lennar recorded a $140 million charge for the Settlers Crossing Maryland property dispute, the high end of its expected liability range after appellate oral argument. A separate $114 million property purchase may also be required and was described as approximating the property’s estimated fair value. The appeal outcome is uncertain; reversal would eliminate the purchase obligation and related accrual, while further trial-court proceedings could change the accrual.
- Management outlook: Lennar expected to deliver 29,500–30,000 homes in fiscal 2017 and anticipated a slightly higher growth rate than the prior year, partly reflecting WCI. It expected lower gross margins in Q2 FY2017 than Q2 FY2016 because costs were rising faster than selling prices, competition persisted, and purchase accounting increased the value of WCI backlog. Management cited housing demand and economic conditions as supportive, but identified land and labor constraints and affordability and mortgage-financing limits as restraints.
- Other exposures: Lennar cited risks from housing-market or economic deterioration, higher operating costs, land acquisition and development, mortgage-market conditions, joint-venture commitments, refinancing and legal outcomes. It had $431.7 million of letters of credit and $1.4 billion of surety bonds outstanding; management did not expect material effects from draws. The company expects monetary sanctions from EPA stormwater violations at certain Florida communities but currently does not expect them to be material. Rialto’s FDIC portfolio partners exercised cleanup-call rights; Rialto must liquidate and sell portfolio assets within 150 days, after which the FDIC may sell any remaining assets.
Investor verification priorities
- Track the Settlers Crossing appeal, the $140 million accrual, and any separate property-purchase obligation or change in expected liability.
- Assess whether home-delivery growth and backlog convert to revenue while incentives, construction and land costs, and gross margins evolve as management projected.
- Review WCI integration, provisional purchase accounting, transaction costs, and the effect of acquisition financing on leverage and interest expense.
- Monitor liquidity, debt maturities, revolving-credit covenant headroom, and renewal or replacement of warehouse facilities.
- Check Rialto impairments and FDIC portfolio liquidation progress, as well as joint-venture commitments, guarantees, and multifamily development results.