UNITED STATESSECURITIES AND EXCHANGE COMMISSION
FORM 10-Q
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number 1-9804
PULTE HOMES, INC.
100 Bloomfield Hills Parkway, Suite 300Bloomfield Hills, Michigan 48304(Address of principal executive offices) (Zip Code)
Registrant’s telephone number, including area code (248) 647-2750
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Sections 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding twelve months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to the filing requirements for the past 90 days. YES (ü) NO ( )
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12-b2 of the Exchange Act).YES (ü) NO ( )
Number of shares of common stock outstanding as of October 29, 2004: 127,554,884
Website Access to Company Reports, Codes and Charters
Our internet website address is www.pulte.com. Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to section 13(a) or 15(d) of the Exchange Act are available free of charge through our website as soon as reasonably practicable after we electronically file with or furnish them to the Securities and Exchange Commission. Our code of ethics for principal officers, our corporate governance guidelines and the charters of the Audit, Compensation, and Nominating and Governance Committees of our Board of Directors are also posted on our website and are available in print upon request.
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Note: The condensed consolidated balance sheet at December 31, 2003 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements.
See accompanying Notes to Condensed Consolidated Financial Statements.
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The consolidated financial statements include the accounts of Pulte Homes, Inc. and all of its direct and indirect subsidiaries (the “Company”). The direct subsidiaries of Pulte Homes, Inc. include Pulte Diversified Companies, Inc., Del Webb Corporation (“Del Webb”) and other subsidiaries that are engaged in the homebuilding business. Pulte Diversified Companies, Inc.’s operating subsidiaries include Pulte Home Corporation, Pulte International Corporation (“International”) and other subsidiaries that are engaged in the homebuilding business. Pulte Diversified Companies, Inc.’s non-operating thrift subsidiary, First Heights Bank, fsb (“First Heights”), is classified as a discontinued operation. The Company’s operations also include a mortgage banking company, Pulte Mortgage LLC (“Pulte Mortgage”), which is a subsidiary of Pulte Home Corporation.
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and nine-month periods ended September 30, 2004 are not necessarily indicative of the results that may be expected for the year ending December 31, 2004. These financial statements should be read in conjunction with the Company’s consolidated financial statements and footnotes thereto included in the Company’s annual report on Form 10-K for the year ended December 31, 2003.
Certain amounts previously reported in the 2003 financial statements and notes thereto were reclassified to conform to the 2004 presentation. In addition, all share and per share amounts have been restated to reflect the Company’s two-for-one stock split effected January 2, 2004.
Home purchasers are provided with warranties against certain building defects. The specific terms and conditions of those warranties vary geographically. Most warranties cover different aspects of the home’s construction and operating systems for a period of up to ten years. The Company estimates the costs to be incurred under these warranties and records a liability for the amount of such costs at the time product revenue is recognized. Factors that affect the Company’s warranty liability include the number of homes sold, historical and anticipated rates of warranty claims, and cost per claim. The Company periodically assesses the adequacy of its recorded warranty liabilities and adjusts the amounts as necessary.
Changes to the Company’s allowance for warranties are as follows ($000’s omitted):
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The Company currently has several stock-based employee compensation plans. Effective January 1, 2003, the Company adopted the preferable fair value recognition provisions of SFAS No. 123, “Accounting for Stock Issued to Employees.” The Company selected the prospective method of adoption as permitted by SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure.” Under the prospective method, the Company recognizes compensation expense based on the fair value provisions of SFAS No. 123 for all new stock option grants effective January 1, 2003. Grants made prior to January 1, 2003 are accounted for under the recognition and measurement principles of APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and related Interpretations. With the exception of certain variable stock option grants, no stock-based employee compensation cost is reflected in net income for grants made prior to January 1, 2003, as all options granted in those years had an exercise price equal to the market value of the underlying common stock on the date of grant.
The following table illustrates the effect on net income and earnings per share as if the fair value method had been applied to all outstanding stock options in each period. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model.
The Company also recorded compensation expense for restricted stock awards, net of related tax effects, of $943 thousand and $3 million for the three and nine months ended September 30, 2004, compared with $2.2 million and $4.7 million for the three and nine months ended September 30, 2003. These amounts have been excluded from the reconciliation above as they would have no impact on pro forma net income as presented.
In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities,” as amended by FIN 46-R issued in December 2003 (collectively referred to as “FIN 46”). Until this interpretation was issued, a company generally included another entity in its consolidated financial statements only if it controlled the entity through voting interests. FIN 46 requires a variable interest entity to be consolidated by a company if that company is subject to a majority of the expected losses from the variable interest entity’s activities or is entitled to receive a majority of the entity’s expected residual returns. FIN 46 applied immediately to all variable interest entities created after January 31, 2003 and was effective in the first interim period ending after December 31, 2003 for variable interest entities created prior to February 1, 2003.
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In the ordinary course of business, the Company enters into land option agreements in order to procure land for the construction of homes in the future. Pursuant to these land option agreements, the Company will provide a deposit to the seller as consideration for the right to purchase land at different times in the future, usually at predetermined prices. Under FIN 46, if the entity holding the land under option is a variable interest entity, the Company’s deposit represents a variable interest in that entity.
In applying the provisions of FIN 46, the Company evaluated all land option agreements (including those created prior to February 1, 2003) and determined that the Company was subject to a majority of the expected losses or entitled to receive a majority of the expected residual returns under a limited number of these agreements. As the primary beneficiary under these agreements, the Company is required to consolidate variable interest entities at fair value. At September 30, 2004 and December 31, 2003, the Company classified $99.8 million and $73.3 million, respectively, as land, not owned, under option agreements on the balance sheet, representing the fair value of land under contract, including deposits. The corresponding liability has been classified within accounts payable, accrued and other liabilities on the balance sheet. The adoption of FIN 46 had no impact on the Company’s results of operations or cash flows.
In March 2004, the Securities and Exchange Commission (“SEC”) released SEC Staff Accounting Bulletin No. 105 (“SAB 105”), Application of Accounting Principles to Loan Commitments. SAB 105 provides the SEC staff position regarding the application of accounting principles generally accepted in the United States to loan commitments that relate to the origination of mortgage loans held for resale. SAB 105 contains specific guidance on the inputs to a valuation-recognition model to measure loan commitments accounted for at fair value. Current accounting guidance requires commitments to be recognized on the balance sheet at fair value from inception through expiration or funding. SAB 105 requires that fair-value measurement include only differences between the guaranteed interest rate in the loan commitment and a market interest rate, excluding any expected future cash flows related to the customer relationship or loan servicing. In addition, SAB 105 requires the disclosure of both the accounting policy for loan commitments including the methods and assumptions used to estimate the fair value of loan commitments and any associated hedging strategies. SAB 105 is effective for all loan commitments accounted for as derivatives and entered into subsequent to March 31, 2004. The issuance of SAB 105 had an insignificant impact on our results of operations, financial condition and cash flows.
We have two reportable business segments, Homebuilding and Financial Services, and one non-operating segment, Corporate.
The Homebuilding segment consists of the following operations:
The Financial Services segment consists principally of mortgage banking and title insurance operations conducted through Pulte Mortgage and other subsidiaries.
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Corporate is a non-operating segment that supports the operations of our subsidiaries by acting as the internal source of financing, developing and implementing strategic initiatives centered on new business development and operating efficiencies, and providing the administrative support associated with being a publicly traded entity listed on the New York Stock Exchange.
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Major components of the Company’s inventory were as follows ($000’s omitted):
The Company’s investments in unconsolidated entities totaled $216.1 million at September 30, 2004 and $69.4 million at December 31, 2003. All of these investments are accounted for under the equity method.
During the second quarter of 2004, the Company invested approximately $77.5 million in two joint ventures. These joint ventures develop and/or sell land within the United States. The Company and/or its partners provide varying levels of guarantees on the indebtedness of certain unconsolidated joint ventures.
During January 2004, the Company invested $35 million for a 50% ownership interest in an entity that supplies and installs basic building components and operating systems, with an option to purchase the remaining 50% interest in the entity in July 2006 or earlier under certain circumstances. The Company has certain commitments to the entity under operating and supply agreements, including: funding additional working capital, as determined by the entity’s operating committee on which the Company has 50% representation; and utilization of products and services of this entity for new homes built within certain markets in the western United States. This entity currently has no outstanding indebtedness.
For the nine months ended September 30, 2004, we made additional capital contributions to our investments in unconsolidated entities totaling approximately $43.5 million and received cash distributions from these entities totaling approximately $50 million.
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The Company’s senior notes and subordinated notes at book value are summarized as follows ($000’s omitted):
Total senior note and subordinated note principal maturities during the five years after 2004 are as follows: 2005 – $125 million; 2006 – $0; 2007 – $0; 2008 – $0; 2009 – $400 million and thereafter – $2.3 billion.
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Our $125 million, 7.3% unsecured senior notes are due in 2005. We anticipate repaying these notes by issuing new unsecured senior notes in 2005.
In September 2004, the Company restructured and amended the 5-year unsecured revolving credit facility, increasing the borrowing availability from $850 million to $1.31 billion, extending the maturity date from September 30, 2008 to September 15, 2009, with pricing more favorable to the Company. The credit facility includes an uncommitted accordion feature, under which it may be increased to $1.5 billion. The Company has the capacity to issue letters of credit up to $750 million. Borrowing availability is reduced by the amount of letters of credit outstanding. The credit facility contains restrictive covenants, the most restrictive of which requires the Company not to exceed a debt-to-total capitalization ratio of 50% as defined in the agreement.
In July 2004, the Company sold $400 million of 4.875% senior notes that mature on July 15, 2009, which are guaranteed by Pulte Homes, Inc. and certain of its 100%-owned subsidiaries. These notes are unsecured and rank equally with all of our other unsecured and unsubordinated indebtedness. Proceeds from this offering were used for the repayment of expiring notes due August 15, 2004 of $112 million, the reduction of short-term borrowings under our unsecured revolving credit facility and for general corporate purposes.
In January 2004, the Company sold $500 million of 5.25% senior notes that mature on January 15, 2014, which are guaranteed by Pulte Homes, Inc. and certain of its 100%-owned subsidiaries. These notes are unsecured and rank equally with all of our other unsecured and unsubordinated indebtedness. Proceeds from the sale were used to retire the $77 million outstanding Del Webb 10.25% senior subordinated notes and for general corporate purposes, including continued investment in our business.
In December 2003, under the terms of Del Webb’s $150 million 10.25% senior subordinated notes due 2010, the Company exercised its optional right to call for the redemption of the remaining outstanding principal balance of approximately $77 million. The notes were redeemed in February 2004 at a price equal to 105.125% of the principal amount.
The Company recorded non-cash, after-tax gains of $10.8 million and $7.9 million during the third quarter of 2004 and 2003, respectively, related to the favorable resolution of certain tax matters in connection with its thrift operation, which was discontinued in 1994.
On December 11, 2003 the Company announced a two-for-one stock split effected in the form of a 100 percent stock dividend. The distribution was made on January 2, 2004. All share and per share amounts have been restated to retroactively reflect the stock split.
In October 2002, the Company’s Board of Directors authorized the repurchase of $100 million of Pulte Homes, Inc. common stock in open-market transactions or otherwise. As of September 30, 2004, we have repurchased a total of 990,800 shares for a total of $22.5 million. No repurchases occurred during the nine months ended September 30, 2004.
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In April 2004, the Company received a request for information from the United States Environmental Protection Agency (“EPA”) pursuant to Section 308 of the Clean Water Act. The request seeks information about storm water discharge practices in connection with homebuilding projects completed or underway by the Company. The Company has provided the EPA with this information. Although the matter has since been referred to the United States Department of Justice (“DOJ”) for enforcement, the EPA has asked that the Company engage in “pre-filing” negotiations to resolve the matter short of litigation. The Company is actively engaged in these negotiations. If the negotiations fail and the DOJ alleges that the Company has violated regulatory requirements applicable to storm water discharges, the government may seek injunctive relief and penalties. The Company believes that it has defenses to any such allegations. At this time, however, the Company can neither predict the outcome of this inquiry, nor can it currently estimate the costs that may be associated with its eventual resolution.
At September 30, 2004, Pulte Homes, Inc. had the following outstanding senior note obligations: (1) $125 million, 7.3%, due 2005, (2) $400 million, 4.875% due 2009, (3) $200 million, 8.125%, due 2011, (4) $499 million, 7.875%, due 2011, (5) $300 million, 6.25%, due 2013, (6) $500 million, 5.25%, due 2014, (7) $150 million, 7.625%, due 2017, (8) $300 million, 7.875%, due 2032, and (9) $400 million, 6.375%, due 2033. Such obligations to pay principal, premium, if any, and interest are guaranteed jointly and severally on a senior basis by Pulte Homes, Inc.’s 100%-owned Domestic Homebuilding subsidiaries (collectively, the Guarantors). Such guarantees are full and unconditional.
Supplemental consolidating financial information of the Company, specifically including such information for the Guarantors, is presented below. Investments in subsidiaries are presented using the equity method of accounting. Separate financial statements of the Guarantors are not provided as the consolidating financial information contained herein provides a more meaningful disclosure to allow investors to determine the nature of the assets held by, and the operations of, the combined groups.
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CONDENSED CONSOLIDATING BALANCE SHEETSeptember 30, 2004($000’s omitted)
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CONDENSED CONSOLIDATING BALANCE SHEETDecember 31, 2003($000’s omitted)
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CONSOLIDATING STATEMENT OF OPERATIONSFor the three months ended September 30, 2004($000’s omitted)
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CONSOLIDATING STATEMENT OF OPERATIONSFor the nine months ended September 30, 2004($000’s omitted)
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CONSOLIDATING STATEMENT OF OPERATIONSFor the three months ended September 30, 2003($000’s omitted)
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CONSOLIDATING STATEMENT OF OPERATIONSFor the nine months ended September 30, 2003($000’s omitted)
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CONSOLIDATING STATEMENT OF CASH FLOWSFor the nine months ended September 30, 2004($000’s omitted)
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CONSOLIDATING STATEMENT OF CASH FLOWS (continued)For the nine months ended September 30, 2004($000’s omitted)
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CONSOLIDATING STATEMENT OF CASH FLOWSFor the nine months ended September 30, 2003($000’s omitted)
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CONSOLIDATING STATEMENT OF CASH FLOWS (continued)For the nine months ended September 30, 2003($000’s omitted)
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview:
A summary of our operating results by business segment for the three-month and nine-month periods ended September 30, 2004 and 2003 is as follows ($000’s omitted):
Key financial highlights and events for the three-month and nine-month periods ended September 30, 2004 and 2003 are as follows:
Homebuilding Operations
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Overview (continued)
Financial Services Operations
Corporate
Homebuilding Operations:
Our Homebuilding segment consists of the following operations:
Certain operating data relating to our homebuilding operations are as follows ($000’s omitted):
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Homebuilding Operations (continued)
Domestic Homebuilding
The Domestic Homebuilding business unit represents our core business. Our operations are conducted in 45 markets located throughout 27 states, presented geographically as follows:
The following table presents selected unit information for our Domestic Homebuilding operations:
Continued strong demand for new homes was the primary driver for increases in net new orders, unit settlements and unit backlog.
Net new orders increased 11%, to a record 10,109 units, for the three months ended September 30, 2004. Net new orders for the nine months ended September 30, 2004 increased 19% to 31,636 units.
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Unit settlements also set a record for the three-month period at 9,669 units, an increase of 12% over the same period in 2003. Unit settlements for the nine-month period increased to 25,188 units, an increase of 17% over the same period in 2003. The average selling price for homes closed increased 11% to $291,000 for the three months ended September 30, 2004, and 10% to $284,000 for the nine months then ended. Changes in average unit selling price reflect a number of factors, including changes in market selling prices, primarily in the West, and geographic and product mix.
Ending backlog, which represents orders for homes that have not yet closed, grew to a record 20,400 units at September 30, 2004. The dollar value of our backlog was up 38% to $6.4 billion at September 30, 2004, compared with $4.7 billion at September 30, 2003. Our most significant increases occurred in the Southeast, Midwest and West, which had increases of 31%, 16% and 30% respectively.
As announced on October 4, 2004, we lowered pricing in Las Vegas to better align our communities with pricing in the market. This action was in response to a period of slow sign-ups and increased cancellation rates, which we attributed to our then above-market pricing. The price reductions only impacted the units in backlog at September 30, 2004 and did not have a material effect on homebuilding settlement revenues for the third quarter. Las Vegas backlog totaled 1,550 units, with a value of $760.6 million at September 30, 2004, which represented 7.6% and 11.8% of total domestic homebuilding units and dollars, respectively. The effect of price reductions decreased the value of the Las Vegas backlog by approximately $233 million. Of this decrease, approximately 326 units or $156 million represented cancellations. After considering the impact of the price reductions and cancellations, the Las Vegas backlog, as of September 30, 2004, represents 6.1% and 8.5% of total domestic homebuilding units and dollars in backlog, respectively. Since the price reductions took effect in October of 2004, our communities in Las Vegas have experienced improved traffic and new order activity, compared with the third quarter.
The West contributed the largest portion of our operating activities, compared with the other geographic areas in the domestic homebuilding operations, representing 35% of unit net new orders and 36% of unit settlements for the three months ended September 30, 2004 and 39% of unit net new orders and 39% of unit settlements for the nine months ended September 30, 2004 and 41% of the total Domestic Homebuilding backlog at September 30, 2004.
Domestic homebuilding net new orders in the Southeast were higher during the three-month and nine-month periods of 2004, compared with the same periods in 2003. Despite four hurricanes experienced throughout Florida and the southeastern areas of the United States during August and September of 2004, we sustained minimal property damage. We experienced delayed home settlements and incurred additional overhead expenses related to lost workdays and cleanup efforts undertaken as a result of the hurricanes. Further, the impact of the storms delayed the opening of several new communities and slowed the pace of sign-ups by an estimated 200 units. Additionally, pre-tax income was unfavorably impacted by an estimated $13 million primarily as a result of approximately 220 delayed closings.
The following table presents markets that represent 10% or more of unit new orders, unit settlements, and settlement revenues for the three and nine months ended September 30, 2004 and 2003:
* Represents less than 10%.
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The following table presents a summary of pre-tax income for our Domestic Homebuilding operations for the three and nine months ended September 30, 2004 and 2003 ($000’s omitted):
Homebuilding gross profit margins from home settlements increased to 23.5% and 22.6% for the three and nine months ended September 30, 2004, compared with 20.4% and 20.5%, respectively, for the same periods in the prior year. This increase is primarily attributable to product price increases and favorable shifts in product and geographic mix.
We consider land acquisition one of our core competencies. We acquire land primarily for the construction of our homes for sale to homebuyers. We will often sell select parcels of land within or adjacent to our communities to retail and commercial establishments. We also will, on occasion, sell lots within our communities to other homebuilders. The pre-tax income contribution from land sales for the quarter increased $12.6 million to $19.8 million when compared with the prior year period. Revenues and their related gains/losses may vary significantly between periods, depending on the timing of land sales. We continue to evaluate our existing land positions to ensure the most effective use of capital.
Selling, general and administrative expenses as a percentage of home settlement revenues improved by approximately 40 basis points to 8.9% for the three months ended and 70 basis points to 9.5% for the nine months ended September 30, 2004. This improvement can be attributed to greater leverage as a result of volume increases and the favorable pricing environment for our homes.
Equity income for the three and nine months ended September 30, 2004 primarily includes earnings from our 50% investment in the joint venture that supplies and installs basic building components and operating systems, acquired in January 2004, and two Nevada-based joint ventures related to the sale of commercial and residential properties. Equity income for the three and nine months ended September 30, 2003 primarily includes earnings from our two Nevada-based joint ventures.
Other income (expense), net, which includes several miscellaneous items, increased for the three and nine-month periods, primarily attributed to increased write-offs of deposits and pre-acquisition costs resulting from decisions not to pursue certain land acquisitions and options, coupled with insurance-related expenses and settlements and disposals of fixed assets.
At September 30, 2004 and December 31, 2003, our Domestic Homebuilding operations controlled approximately 335,400 and 256,900 lots, respectively. Approximately 159,500 and 120,400 lots were owned, and approximately 106,100 and 66,000 lots were under option agreements approved for purchase at September 30, 2004 and December 31, 2003, respectively. In addition, there were approximately 69,800 and 70,500 lots under option agreements, pending approval, at September 30, 2004 and December 31, 2003, respectively.
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The total purchase price applicable to land under option approved for use by our homebuilding operations at future dates approximated $4 billion at September 30, 2004, compared with $2.6 billion at December 31, 2003. In addition, total purchase price applicable to land under option pending approval was valued at $2.6 billion at September 30, 2004 compared with $2.1 billion at December 31, 2003. Land option agreements, which may be cancelled at our discretion, may extend over several years and are secured by cash deposits totaling $207.7 million, which are generally non-refundable.
International Homebuilding:
Our International Homebuilding operations are primarily conducted through subsidiaries of International in Mexico, Puerto Rico and Argentina. We continue to evaluate various long-term strategic alternatives with regard to our International operations.
The following table presents selected financial data for our International Homebuilding operations for the three and nine months ended September 30, 2004 and 2003 ($000’s omitted):
Note: Homebuilding unit settlements of affiliates, not included in the table above, for the three months ended September 30, 2004 and 2003 were 54 and 29, respectively. For the nine months ended September 30, 2004 and 2003, homebuilding units of affiliates, not included in the table above, were 168 and 114, respectively.
International unit settlements for the three and nine months ended September 30, 2004, increased 1% and 11% respectively. International revenues for the three and nine months ended September 30, 2004 decreased 10% and 5%, respectively, over the prior year periods. The decrease in International revenues is the result of a higher proportion of unit settlements from our operations in Mexico, the country in which average sales price per unit is lowest of our International operations.
The higher proportion of unit settlements derived from Mexico, coupled with a higher percentage of those closings coming from economic housing, which is the lowest price point served in Mexico, had a negative impact on gross margins. Gross margins decreased approximately 150 basis points to 19.2% for the three months ended September 30, 2004 and 100 basis points to 19.2% for the nine months ended September 30, 2004. Selling, general and administrative expenses as a percent of revenues declined to 16.7% from 17.9% for the three-month period and to 18.0% from 20.6% for the nine-month period as Mexico began to see the benefits of restructuring actions taken during 2003.
At September 30, 2004, our investments in Puerto Rico approximated $32.8 million. Our operations in Argentina and Mexico are affected by fluctuations in currency rates for those countries. Transaction gains and losses for the three and nine months ended September 30, 2004 and 2003, included in other income (expense), net, were not significant. At September 30, 2004, our investments in Argentina and Mexico, net of accumulated foreign currency translation adjustments, approximated $12.1 million and $68.7 million, respectively.
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Financial Services Operations:
We conduct our financial services business, which includes mortgage and title insurance operations, through Pulte Mortgage and other subsidiaries.
The following table presents mortgage origination data for our Financial Services operations:
Pre-tax income of our financial services operations for the three and nine months ended September 30, 2004 was $11.3 million and $29.8 million, respectively, compared with $13.4 million and $51.4 million for the prior year periods. The decrease in pre-tax income can be attributed to a shift in our product mix to ARMs, which generally have a lower profit per loan than fixed rate products. The shift in product mix is attributable to customer mortgage product preference.
ARMs represented 45% of total funded origination dollars and 44% of total funded origination units for the three months ended September 30, 2004, compared with 27% and 24% respectively, in the prior year three-month period. ARMs represented 40% of total funded origination dollars and 39% of total funded origination units for the nine months ended September 30, 2004, compared with 21% and 19%, respectively, in the prior year nine-month period. Refinancings approximated 2% and 3% of total unit originations for the three and nine-month periods ended September 30, 2004, compared with 9% and 10% for both prior year periods.
Mortgage origination unit volume for the three and nine months ended September 30, 2004 increased 16% and 17%, respectively, compared with the same period in the prior year. Mortgage origination principal volume for the three and nine months ended September 30, 2004 increased 27% and 29%, respectively, compared with the same period in the prior year. The growth is attributable to an increase in the capture rate from 83.1% to 87.3% for the three-month period and 82.4% to 87.3% for the nine-month period combined with the volume increases experienced in our homebuilding business and an increase in the average loan size. Our Domestic Homebuilding customers continue to represent the majority of total loan production, representing 93% and 90% of total Pulte Mortgage unit production for the three and nine months ended September 30, 2004, respectively, compared with 82% and 81%, respectively, for the same periods in the prior year.
At September 30, 2004, loan application backlog increased to $4 billion, compared with $2.7 billion at September 30, 2003.
Income from our title insurance operations increased to $4.4 million for the three months ended September 30, 2004, from $3.7 million in 2003, and to $11.2 million for the nine months ended, from $8.8 million in 2003. Our minority interest in Su Casita, a Mexican mortgage banking company, contributed income of $1.3 million for the three months ended September 30, 2004, compared with $800 thousand in 2003, and $2.3 million for the nine months ended September 30, 2004, compared with $3.1 million in 2003.
We hedge portions of our forecasted cash flow from sales of closed mortgage loans with derivative financial instruments to minimize the impact of changes in interest rates. We do not use derivative financial instruments for trading purposes.
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Corporate:
Corporate is a non-operating segment that supports the operations of our subsidiaries by acting as the internal source of financing, developing and implementing strategic initiatives centered on new business development and operating efficiencies, and providing the administrative support associated with being a publicly traded entity listed on the New York Stock Exchange. As a result, the Corporate segment’s operating results will vary from quarter to quarter as these strategic initiatives evolve.
The following table presents results of operations for this segment for the three and nine months ended September 30, 2004 and 2003 ($000’s omitted):
Interest expense, net of interest capitalized into inventory, increased $2 million and $7.2 million in the three and nine months ended September 30, 2004. This is a result of the continued increase in debt levels necessary to support our growth. Interest incurred for the three and nine months ended September 30, 2004, excluding interest incurred by our Financial Services operations, was approximately $55.3 million and $154.5 million, respectively.
The increase in other corporate expenses, net for the three months ended September 30, 2004, compared with the same period in the prior year, is attributed to increased compensation-related expenses. For the nine months ended September 30, 2004, the increase is from increased charitable contributions expenses, and increased compensation-related expense, compared with the prior year. Additionally, during the second quarter of 2003, we recognized income from the sale and adjustment to fair value of various non-operating parcels of commercial land held for sale.
Interest capitalized into inventory is charged to home cost of sales based on the cyclical timing of our unit settlements over a period that approximates the average life cycle of our communities. Interest in inventory has increased primarily as a result of higher levels of indebtedness to support the growth of the business. Information related to Corporate interest capitalized into inventory is as follows ($000’s omitted):
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Liquidity and Capital Resources:
We finance our homebuilding land acquisitions, development and construction activities from internally generated funds and existing credit agreements.
At September 30, 2004, we had cash and equivalents of $116.4 million, $2.9 billion of senior notes outstanding, and $567.3 million of borrowings under the unsecured revolving credit facility. Other financing included limited recourse collateralized financing totaling $83.3 million. Sources of our working capital include our cash and equivalents, our $1.3 billion committed unsecured revolving credit facility and Pulte Mortgage’s $940 million committed credit arrangements.
Our debt-to-total capitalization, excluding our collateralized debt, was approximately 45.5% at September 30, 2004, and approximately 44.7% net of cash and equivalents. These levels are consistent with our expectations for the third quarter as our inventory peaked with over 20,000 homes. With the buildup of inventory for deliveries in the fourth quarter, we anticipate the net debt-to-total capitalization ratio to be at approximately the 40% level at the end of the year. We routinely monitor current operational requirements and financial market conditions to evaluate the use of available financing sources, including securities offerings.
Pulte Mortgage provides mortgage financing for many of our home sales and uses its own funds and borrowings made available pursuant to various committed and uncommitted credit arrangements. At September 30, 2004, Pulte Mortgage had committed credit arrangements of $940 million comprised of a $390 million bank revolving credit facility and a $550 million annual asset-backed commercial paper program.
Our effective tax rate at September 30, 2004 was 38%. We anticipate that our effective tax rate for 2004 will approximate 38%, the same as our 2003 effective tax rate.
Our net cash used in operating activities amounted to $1.2 billion, compared with net cash used in operating activities of $460.4 million in the prior year period. This change was primarily driven by an increase in inventories.
Cash used in investing activities was $155.3 million for the nine months ended September 30, 2004, compared with $4.1 million in the prior year. The change in net cash used in investing activities primarily relates to our investments in unconsolidated entities. During January 2004, we invested $35 million for a 50% ownership interest in an entity that supplies and installs basic building components and operating systems. During the second quarter of 2004, we invested approximately $77.5 million in two joint ventures that develop and/or sell land within the United States. Also, we contributed $43.5 million of additional capital contributions to and received $50 million in distributions from our unconsolidated joint ventures during the nine months ended September 30, 2004. Further, we incurred approximately $54.8 million in capital expenditures to support the growth of our business.
Net cash provided by financing activities totaled $1.1 billion for the nine months ended September 30, 2004, compared with $164.4 million in the prior year. Cash inflows from financing activities for the nine months ended September 30, 2004 are attributed to proceeds received from our $500 million, 5.25% senior notes issued in January 2004 and $400 million, 4.875% senior notes issued in July 2004, borrowings of $567.3 million under the unsecured revolving credit facility, and $37 million of cash received from the exercise of stock options. Cash outflows from financing activities for the nine months ended September 30, 2004 primarily relate to payments on Pulte Mortgage’s revolving credit facility of $192.4 million, repayment of our $112 million, 8.375% senior notes in August 2004, redemption of the remaining $77 million of Del Webb 10.25% senior subordinated notes in February 2004, and $19.1 million of cash dividends paid to our shareholders.
Our $125 million, 7.3% unsecured senior notes are due in 2005. We anticipate repaying these notes in 2005 by issuing new unsecured senior notes and/or using cash provided by operations.
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Liquidity and Capital Resources (continued)
In September 2004, we restructured and amended the 5-year unsecured revolving credit facility, increasing the borrowing availability from $850 million to $1.31 billion, extending the maturity date from September 30, 2008 to September 15, 2009, with pricing more favorable to the Company. The credit facility includes an uncommitted accordion feature, under which the credit facility may be increased to $1.5 billion. The Company has the capacity to issue letters of credit up to $750 million. Borrowing availability is reduced by the amount of letters of credit outstanding. The credit facility contains restrictive covenants, the most restrictive of which requires the Company not to exceed a debt-to-total capitalization ratio of 50% as defined in the agreement. We had outstanding borrowings of $567.3 million under this unsecured revolving credit facility at September 30, 2004.
In September 2004, Pulte Mortgage amended its commercial paper conduit, which increased a sub-limit for eligible collateral, eliminated the $50 million quarterly accordion feature, and made pricing more favorable to Pulte Mortgage. The commercial paper conduit is a $550 million committed line of credit and contains restrictive covenants, which include Pulte Mortgage maintain a minimum net worth of $30 million and adjusted liabilities cannot exceed 12 times adjusted net worth. We had outstanding borrowings of $230 million under the commercial paper conduit at September 30, 2004.
In July 2004, we expanded the capacity on Pulte Mortgage’s revolving credit facility from $355 million to $390 million. There were approximately $56.4 million of borrowings outstanding under Pulte Mortgage’s revolving credit facility at September 30, 2004. Mortgage loans originated by Pulte Mortgage are subsequently sold to outside investors. We anticipate that there will be adequate mortgage financing available for purchasers of our homes.
In July 2004, we sold $400 million of 4.875% senior notes, which mature on July 15, 2009 and are guaranteed by Pulte Homes, Inc. and certain of its 100%-owned subsidiaries. These notes are unsecured and rank equally with all of our other unsecured and unsubordinated indebtedness. Proceeds from this offering were used for the repayment of expiring notes due on August 15, 2004 of approximately $112 million and for general corporate purposes, including continued investment in our business.
In January 2004, we sold $500 million of 5.25% senior notes, which mature on January 15, 2014 and are guaranteed by Pulte Homes, Inc. and certain of its 100%-owned subsidiaries. These notes are unsecured and rank equally with all of our other unsecured and unsubordinated indebtedness. Proceeds from the sale were used to retire the $77 million outstanding Del Webb 10.25% senior subordinated notes and for general corporate purposes, including continued investment in our business.
At September 30, 2004, we had remaining authorization to purchase common stock aggregating $77.5 million, pursuant to our $100 million share repurchase program. As of September 30, 2004, we have repurchased a total of 990,800 shares for a total of $22.5 million. We did not repurchase any shares under the share repurchase program during 2004.
At September 30, 2004, we had $600 million remaining under our current mixed security shelf registration.
Inflation
We, and the homebuilding industry in general, may be adversely affected during periods of high inflation because of higher land and construction costs. Inflation also increases our financing, labor and material costs. In addition, higher mortgage interest rates significantly affect the affordability of permanent mortgage financing to prospective homebuyers. We attempt to pass to our customers any increases in our costs through increased sales prices. To date, inflation has not had a material adverse effect on our results of operations. However, there is no assurance that inflation will not have a material adverse impact on our future results of operations.
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New Accounting Pronouncements:
In March 2004, the Securities and Exchange Commission (“SEC”) released SEC Staff Accounting Bulletin (“SAB”) 105, Application of Accounting Principles to Loan Commitments. SAB 105 provides the SEC staff position regarding the application of accounting principles generally accepted in the United States to loan commitments that relate to the origination of mortgage loans held for resale. SAB 105 contains specific guidance on the inputs to a valuation-recognition model to measure loan commitments accounted for at fair value. Current accounting guidance requires the commitment to be recognized on the balance sheet at fair value from its inception through its expiration or funding. SAB 105 requires that fair-value measurement include only differences between the guaranteed interest rate in the loan commitment and a market interest rate, excluding any expected future cash flows related to the customer relationship or loan servicing. In addition, SAB 105 requires the disclosure of both the accounting policy for loan commitments including the methods and assumptions used to estimate the fair value of loan commitments and any associated hedging strategies. SAB 105 is effective for all loan commitments accounted for as derivatives and entered into subsequent to March 31, 2004. The issuance of SAB 105 had an insignificant impact on our results of operations, financial condition and cash flows.
Critical Accounting Policies and Estimates:
There have been no significant changes to our critical accounting policies and estimates during the nine months ended September 30, 2004 compared with those disclosed in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our annual report on Form 10-K for the year ended December 31, 2003.
Item 3. Quantitative and Qualitative Disclosure About Market Risk
Quantitative disclosure:
We are subject to interest rate risk on our rate-sensitive financing to the extent long-term rates decline. The following table sets forth, as of September 30, 2004, our rate-sensitive financing obligations, principal cash flows by scheduled maturity, weighted-average interest rates and estimated fair market values ($000’s omitted).
Qualitative disclosure:
This information can be found in Item 7A., Quantitative and Qualitative Disclosures about Market Risk, of our Annual Report on Form 10-K for the fiscal year ended December 31, 2003, and is incorporated herein by reference.
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Special Notes Concerning Forward-Looking Statements
As a cautionary note, except for the historical information contained herein, certain matters discussed in Item 2., Management’s Discussion and Analysis of Financial Condition and Results of Operations and Item 3.,Quantitative and Qualitative Disclosures About Market Risk, are “forward-looking” statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements involve known risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements. Such factors include, among other things, (1) general economic and business conditions; (2) interest rate changes and the availability of mortgage financing; (3) the relative stability of debt and equity markets; (4) competition; (5) the availability and cost of land and other raw materials used in our homebuilding operations; (6) the availability and cost of insurance covering risks associated with our business; (7) shortages and the cost of labor; (8) weather related slowdowns; (9) slow growth initiatives and/or local building moratoria; (10) governmental regulation, including the interpretation of tax, labor and environmental laws; (11) changes in consumer confidence and preferences; (12) required accounting changes; (13) terrorist acts and other acts of war; and (14) other factors over which we have little or no control.
Item 4. Controls and Procedures
Management, including our President & Chief Executive Officer and Executive Vice President & Chief Financial Officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of September 30, 2004. Based upon, and as of the date of that evaluation, our President & Chief Executive Officer and Executive Vice President & Chief Financial Officer concluded that the disclosure controls and procedures were effective, in all material respects, to ensure that information required to be disclosed in the reports we file and submit under the Exchange Act is recorded, processed, summarized and reported as and when required. There have been no changes in our internal control over financial reporting during the quarter ended September 30, 2004 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit Number and Description
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Exhibits (continued)
(b) Reports on Form 8-K
On September 13, 2004, we filed a Current Report on Form 8-K, reporting the information required by Item 8.01, announcing that Leo Taylor had notified the company that he was resigning as Executive Vice President – Human Resources of Pulte Homes, Inc. for personal reasons.
On September 15, 2004, we filed a Current Report on Form 8-K, reporting the information required in Items 5.03 and 9.01, announcing that the Board of Directors approved an amendment to Article VI of the bylaws of the Company which requires the Company to provide mandatory indemnification and expense advancement, to the full extent permitted by Michigan law, to its officers and directors.
On September 16, 2004, we filed a Current Report on Form 8-K, reporting the information required in Items 1.01 and 2.03, announcing the Company restructured and amended the 5-year unsecured revolving credit facility, increasing the borrowing availability from $850 million to $1.31 billion, extending the maturity date from September 30, 2008 to September 15, 2009, with pricing more favorable to the Company.
On October 5, 2004, we filed a Current Report on Form 8-K, reporting the information required in Item 2.02, announcing the Company had updated earnings guidance for the third quarter and full year 2004.
On October 26, 2004, we filed a Current Report on Form 8-K, reporting the information required by Item 2.02 in connection with our press release dated October 25, 2004, announcing our earnings for the three-month and nine-month periods ended September 30, 2004. No financial statements were filed, although we furnished the financial information included in the press release with the Form 8-K.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
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Exhibit Index