Why did Lennar's earnings decline so sharply in fiscal 2006?

Earnings fell because market conditions deteriorated in the second half of 2006, driven by excess supply as speculators returned homes to the market and negative customer sentiment. The company recorded $501.8 million of inventory valuation adjustments and $126.4 million of valuation adjustments on unconsolidated entity investments, and used substantially higher sales incentives, which lowered gross margins on home sales to 18.4% from 26.0%.

How strong is Lennar's balance sheet?

Management described its balance sheet as a source of strength. Homebuilding debt to total capital was 31.4% at November 30, 2006, compared with 33.1% a year earlier, and stockholders' equity was $5.70 billion. The company had no outstanding balance under its $2.7 billion New Facility, and it called its $200 million floating-rate notes due 2007 during November 2006.

What is the outlook for 2007?

Management stated that conditions had not yet recovered as the company entered the first quarter of 2007. It expects deliveries in 2007 to be at least 20% lower than in 2006, will keep starts aligned with demand, and plans to rebuild margins by reducing SG&A and construction costs and renegotiating land prices.

What is the LandSource transaction and what could it mean for earnings?

On December 29, 2006, Lennar and LNR agreed to admit a new strategic partner into the LandSource joint venture, resulting in a cash distribution of approximately $660 million to each of the two existing partners. The transaction is expected to generate approximately $500 million in earnings for Lennar, with about $125 million recognized at closing and a potential $375 million realized over future years. The transaction is expected to close in the first quarter of 2007.

What are the main risks highlighted in the filing?

Key risks include a continued decline in demand or further decline in new home prices, which could lead to additional inventory impairments; increases in mortgage interest rates and tighter lending standards affecting buyers of non-traditional mortgages; warranty and construction defect claims; limited availability and rising cost of land and labor; dependence on joint venture partners; and Stuart A. Miller's approximately 49% voting power, which gives him significant influence over stockholder votes.

LEN/LEN-B 10-K FY2006 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed February 8, 2007. Cited figures are marked; the original filing is the authoritative source.

Lennar Corporation (LEN) reported a sharp downturn in fiscal 2006 (year ended November 30, 2006).

Net earnings from continuing operations fell to $593.9 million^a, or $3.69 per diluted share, from $1.3 billion, or $8.17 per diluted share, in 2005. Revenues from home sales still rose 17% to $14.9 billion, driven by a 15% increase in home deliveries to 49,568 total homes (including unconsolidated entities). However, gross margin on home sales fell to 18.4% from 26.0%, reflecting $501.8 million of inventory valuation adjustments, $126.4 million of valuation adjustments on unconsolidated entity investments, and average sales incentives of $32,000 per home delivered, up from $9,000 in 2005.

Management stated that market conditions deteriorated in the second half of 2006, with excess supply from speculators, slower sales (down 3%) and a cancellation rate of 29%. The balance sheet remained comparatively strong. Homebuilding debt to total capital declined to 31.4% from 33.1%, stockholders' equity rose to $5.70 billion^b, and the company called its $200 million floating-rate notes due 2007 and issued $500 million of new senior notes in April 2006.

Cash related to homebuilding and financial services operations was $778.3 million^c at year-end. Management guided that 2007 deliveries will be at least 20% lower than in 2006 as it matches starts to demand and focuses on rebuilding margins. A subsequent event disclosed in the filing is a December 29, 2006 agreement to admit a new strategic partner into the LandSource joint venture, expected to generate approximately $500 million in earnings for Lennar, of which about $125 million would be recognized at closing, with the transaction expected to close in the first quarter of 2007.

02—Key points

Key Highlights

Net earnings from continuing operations were $593.9 million, or $3.69 per diluted share, down from $1.3 billion, or $8.17 per diluted share, in 2005.
Gross margin on home sales decreased to 18.4% from 26.0%, including $501.8 million of total inventory valuation adjustments recorded in 2006.
Home deliveries rose to 49,568 (including unconsolidated entities) from 42,359, while the average sales price increased to $315,000 from $311,000.
Sales incentives rose to $32,000 per home delivered in 2006 from $9,000 in 2005; cancellation rate reached 29% versus 17% in 2005.
Homebuilding debt to total capital improved to 31.4% from 33.1%, and stockholders' equity increased to $5.70 billion.
Backlog declined to 11,608 homes ($4.0 billion) from 18,565 homes ($6.9 billion) at November 30, 2005.
Management expects 2007 deliveries to be at least 20% lower than in 2006, and a LandSource joint venture transaction expected to close in Q1 2007 is projected to generate about $500 million in earnings.

03—Questions

Frequently Asked Questions

Why did Lennar's earnings decline so sharply in fiscal 2006?
Earnings fell because market conditions deteriorated in the second half of 2006, driven by excess supply as speculators returned homes to the market and negative customer sentiment. The company recorded $501.8 million of inventory valuation adjustments and $126.4 million of valuation adjustments on unconsolidated entity investments, and used substantially higher sales incentives, which lowered gross margins on home sales to 18.4% from 26.0%.
How strong is Lennar's balance sheet?
Management described its balance sheet as a source of strength. Homebuilding debt to total capital was 31.4% at November 30, 2006, compared with 33.1% a year earlier, and stockholders' equity was $5.70 billion. The company had no outstanding balance under its $2.7 billion New Facility, and it called its $200 million floating-rate notes due 2007 during November 2006.
What is the outlook for 2007?
Management stated that conditions had not yet recovered as the company entered the first quarter of 2007. It expects deliveries in 2007 to be at least 20% lower than in 2006, will keep starts aligned with demand, and plans to rebuild margins by reducing SG&A and construction costs and renegotiating land prices.
What is the LandSource transaction and what could it mean for earnings?
On December 29, 2006, Lennar and LNR agreed to admit a new strategic partner into the LandSource joint venture, resulting in a cash distribution of approximately $660 million to each of the two existing partners. The transaction is expected to generate approximately $500 million in earnings for Lennar, with about $125 million recognized at closing and a potential $375 million realized over future years. The transaction is expected to close in the first quarter of 2007.
What are the main risks highlighted in the filing?
Key risks include a continued decline in demand or further decline in new home prices, which could lead to additional inventory impairments; increases in mortgage interest rates and tighter lending standards affecting buyers of non-traditional mortgages; warranty and construction defect claims; limited availability and rising cost of land and labor; dependence on joint venture partners; and Stuart A. Miller's approximately 49% voting power, which gives him significant influence over stockholder votes.

04—Continue

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