Lennar Corporation — Q1 2018 Form 10-Q
Reporting period: Three months ended February 28, 2018; comparison is with the three months ended February 28, 2017. Lennar is a homebuilder with mortgage and title services, real estate investment/finance, and multifamily operations. CalAtlantic was acquired on February 12, 2018, so reported results include only its post-acquisition activity; prior-year results exclude CalAtlantic.
Key financial results
| Metric | Q1 2018 | Q1 2017 |
|---|---|---|
| Total revenue | $2.981 billion | $2.337 billion |
| Pretax earnings | $269.4 million | $49.6 million |
| Net earnings attributable to Lennar | $136.2 million | $38.1 million |
| Diluted EPS | $0.53 | $0.16 |
| Operating cash flow | $(142.7) million | $79.3 million |
| Cash and cash equivalents, all segments | $1.030 billion at period-end | $929.1 million at prior-year period-end |
- Revenue increased 28%. Homebuilding revenue was $2.662 billion, up from $2.019 billion. Home deliveries excluding unconsolidated entities rose 24% to 6,734; average delivered home price increased 8% to $393,000.
- Reported home-sale gross margin was 19.5%, versus 21.1% a year earlier. Excluding $55.0 million of CalAtlantic purchase-accounting adjustments, the company reported a 21.6% margin. Sales incentives were $22,300 per delivered home, or 5.4% of home-sale revenue, versus $22,700 and 5.9%.
- CalAtlantic contributed $373.4 million of home-sale revenue from acquisition through quarter-end and a $108.5 million pretax loss, including acquisition and integration costs. Reported acquisition and integration costs were $104.2 million.
- Operating cash flow was negative, primarily reflecting a $548.7 million inventory increase, partly offset by a $423.0 million reduction in loans held for sale. Investing cash outflow was $1.028 billion, including $1.102 billion of net cash used for the CalAtlantic acquisition. Financing cash outflow was $450.3 million.
- Homebuilding debt was $10.383 billion, compared with $6.410 billion at November 30, 2017; stockholders’ equity was $13.061 billion. Homebuilding debt-to-total-capital was 44.3%; net debt-to-total-capital was 42.5%, up from 34.4% at November 30, 2017.
- The income-tax provision was $132.6 million and the effective tax rate was 49.3%, including a one-time, non-cash $68.6 million deferred-tax-asset write-down following U.S. tax reform. Excluding that charge, the stated effective rate was 23.8%.
Material changes and notable items
- The $6.232 billion CalAtlantic acquisition materially expanded Lennar’s scale. The provisional purchase-price allocation included approximately $3.3 billion of homebuilding goodwill; valuation and segment allocation remained subject to completion.
- Homebuilding operating earnings included a $164.9 million gain on the sale of an 80% interest in the Treasure Island Holdings joint venture. The prior-year quarter included a $140 million litigation loss related to a Maryland property purchase.
- Segment performance differed: Homebuilding operating earnings were $413.7 million versus $71.3 million; Financial Services earnings were $19.7 million versus $20.7 million; Rialto earnings were $9.2 million versus a $0.8 million loss; Multifamily had a $1.2 million operating loss versus $19.2 million earnings. The prior-year Multifamily result included $26.0 million of gains on property sales, compared with $4.1 million in Q1 2018.
- Cash and cash equivalents fell from $2.651 billion at November 30, 2017 to $1.030 billion at quarter-end, largely reflecting acquisition spending. Homebuilding cash alone was $733.9 million, versus $2.283 billion at November 30.
Outlook, risks and contingencies
- Management said it expected to deliver 45,765 homes in fiscal 2018 and anticipated a strong year of profitability. It expected net margins to improve as CalAtlantic synergies and revenue contributions ramped up; initially, sales and closings were expected to be fairly flat against pro forma prior-year levels, with higher absorption and deliveries later in 2018 and into 2019.
- Management said it was on track to meet or exceed targeted CalAtlantic synergies of $100 million in 2018 and $365 million in 2019. Integration expenses and purchase-accounting effects on acquired backlog and homes in process were expected to continue affecting results in subsequent quarters.
- Management expected to use increased later-year cash flow first to pay down debt and reduce leverage. It had engaged advisers to explore strategic alternatives for Rialto, planned to move Rialto Mortgage Finance into Financial Services, and described a longer-term aim to move toward a more homebuilding-focused company. No agreement for a significant transaction was reported.
- The amended revolving credit facility had a $2.6 billion maximum commitment and $500 million outstanding at quarter-end. Lennar reported covenant compliance; its covenant-calculated leverage ratio was 52.3% against a 65% maximum, and its liquidity test was 2.71 against a 1.00 minimum.
- Outstanding letters of credit totaled $635.7 million; surety bonds totaled $2.4 billion, with about $1.2 billion of associated site-improvement costs still anticipated. Management did not expect draws to materially affect results. Homebuilding joint-venture maximum recourse exposure was $70.1 million; land-option deposits and pre-acquisition costs at risk totaled $202.4 million.
- The mortgage subsidiary had received a DOJ subpoena concerning underwriting and quality-control processes for previously originated and sold FHA loans. Lennar said communications were ongoing and the DOJ had not asserted damages or penalties. Management also cited housing-market, construction-cost, interest-rate, land, integration, financing, legal, and regulatory risks.
Important facts for investors to verify
- Whether CalAtlantic integration costs and the $55.0 million purchase-accounting margin impact unwind as expected, and whether the announced synergy targets are achieved.
- Whether the 45,765-home delivery outlook and projected later-year cash generation translate into improved margins and lower net leverage.
- How much of reported earnings depended on the $164.9 million joint-venture gain, and how margins compare after acquired-home purchase-accounting adjustments.
- Debt maturities, cash usage, refinancing needs, credit-facility covenant headroom, and the post-quarter repayment or conversion of CalAtlantic convertible notes and Rialto’s 7.00% notes.
- Developments in the DOJ FHA-loan inquiry, warranty and legal reserves, joint-venture guarantees, land-option exposure, and any material inventory impairments.
- Progress and financial consequences of the proposed Rialto repositioning and the new multifamily venture commitments.