PulteGroup - 10-Q quarterly report FY

 

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Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES þ NO o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer þ          Accelerated filer o          Non-accelerated filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). YES o NO þ

Number of shares of common stock outstanding as of October 31, 2007: 256,028,800

Note: The condensed consolidated balance sheet at December 31, 2006, 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.

See accompanying Notes to Condensed Consolidated Financial Statements.

See accompanying Notes to Condensed Consolidated Financial Statements.

See accompanying Notes to Condensed Consolidated Financial Statements.

     The consolidated financial statements include the accounts of Pulte Homes, Inc. and all of its direct and indirect subsidiaries (the “Company”) and variable interest entities in which the Company is deemed to be the primary beneficiary. 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 and other subsidiaries that are engaged in the homebuilding business. The Company also has 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 United States generally accepted accounting principles 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 United States generally accepted accounting principles 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 nine months ended September 30, 2007 are not necessarily indicative of the results that may be expected for the year ending December 31, 2007. 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, 2006.

     Certain prior period amounts have been reclassified to conform to the current year presentation.

     Basic earnings per share is computed by dividing income available to common shareholders (the “numerator”) by the weighted-average number of common shares, adjusted for non-vested shares of restricted stock (the “denominator”) for the period. Computing diluted earnings per share is similar to computing basic earnings per share, except that the denominator is increased to include the dilutive effects of options and non-vested shares of restricted stock. Any options that have an exercise price greater than the average market price are considered to be anti-dilutive, and are excluded from the diluted earnings per share calculation. The calculation of diluted earnings per share excludes 21,079,044 and 21,369,728 stock options and shares of restricted stock for the three and nine months ended September 30, 2007, respectively, and 2,483,462 and 2,418,287 stock options and shares of restricted stock for the three and nine months ended September 30, 2006, respectively. For the three and nine months ended September 30, 2007, all stock options and non-vested restricted stock were excluded from the calculation as they were anti-dilutive due to the net loss recorded during the period.

     In accordance with Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long Lived Assets” (SFAS No. 144), the Company records valuation adjustments on land inventory and related communities under development when events and circumstances indicate that they may be impaired and when the cash flows estimated to be generated by those assets are less than their carrying amounts. Such indicators include gross margin or sales paces significantly below expectations, construction costs or land development costs significantly in excess of budgeted amounts, significant delays or changes in the planned development for the community, and other known qualitative factors. For communities that are not yet active, a significant additional consideration includes an evaluation of the regulatory environment related to the probability, timing, and cost of obtaining necessary approvals from local municipalities and any potential concessions that may be necessary in order to obtain such approvals. The Company also considers potential changes to the product offerings in a community and any alternative strategies for the land, such as the sale of the land either in whole or in parcels. The weakened market conditions that arose during 2006 have persisted into 2007 and resulted in lower than expected net new orders, revenues, and gross margins and higher than expected cancellation rates during the nine months ended September 30, 2007. As a result, a portion of the Company’s land inventory and communities under development demonstrated potential impairment indicators and were accordingly tested for impairment. As required by SFAS No. 144, the Company compared the expected undiscounted cash flows for these communities to their carrying value. For those communities whose carrying values exceeded the expected undiscounted cash flows, the Company calculated the fair value of the community. Impairment charges are required to be recorded if the fair value of the community’s inventory is less than its carrying amount. The Company determined the fair value of the community’s inventory using a discounted cash flow model. These estimated cash flows are significantly impacted by estimates related to expected average selling prices and sale incentives, expected sales paces and cancellation rates, expected land development construction timelines, and anticipated land development, construction, and overhead costs. Such estimates must be made for each individual community and may vary significantly between communities. Due to uncertainties in the estimation process, the significant volatility in demand for new housing, and the long life cycles of many communities, actual results could differ significantly from such estimates. The Company’s determination of fair value also requires discounting the estimated cash flows at a rate commensurate with the inherent risks associated with the assets and related estimated cash flow streams. The discount rate used in determining each community’s fair value depends on the stage of development of the community and other specific factors that increase or decrease the inherent risks associated with the community’s cash flow streams. For example, communities that are entitled and near completion will generally require a lower discount rate than communities that are not entitled and consist of multiple phases spanning several years of development and construction activity.

     The Company recorded valuation adjustments of $615.9 million (related to 169 communities) and $48.4 million (related to 27 communities) for the three months ended September 30, 2007 and 2006, respectively, and $1.3 billion (related to 283 communities) and $57.8 million (related to 30 communities) for the nine months ended September 30, 2007 and 2006, respectively, to reduce the carrying value of the impaired assets to their estimated fair value. The Company recorded these valuation adjustments in its Consolidated Statements of Operations within Homebuilding expense. For the three months ended September 30, 2007, the Company performed detailed impairment calculations for 245 communities resulting in impairments for 169 communities. The discount rate used in the Company’s determination of fair value for these 169 communities ranged from 8% to 18% with an aggregate average of 11%, and the remaining carrying value of such communities totaled $822.4 million at September 30, 2007. These 169 communities included 33 of its long-lived active adult communities as well as 60 communities for which impairments were also recorded in prior periods. In the event that market conditions or the Company’s operations deteriorate in the future or the current difficult market conditions extend beyond its expectations, additional impairments may be necessary in the future.

     In accordance with SFAS No. 144, the Company values long-lived assets held for sale at the lower of carrying amount or fair value less cost to sell. The Company records these net realizable value adjustments in its Consolidated Statements of Operations within Homebuilding expense. The Company recognized net realizable valuation adjustments to land held for sale of $80.5 million and $6.7 million for the three months ended September 30, 2007 and 2006, respectively, and $132.8 million and $28.8 million for the nine months ended September 30, 2007 and 2006, respectively.

     From time to time, the Company writes off certain deposits and other costs related to land option contracts the Company no longer plans to pursue. Such decisions take into consideration changes in national and local market conditions, the willingness of land sellers to modify terms of the related purchase agreement, the timing of required land takedowns, the availability and best use of necessary incremental capital, and other factors. The Company wrote off deposits and other related costs in the amount of $94.6 million and $32.6 million for the three months ended September 30, 2007 and 2006, respectively, and $204.2 million and $68.5 million for the nine months ended September 30, 2007 and 2006, respectively. The Company records these write-offs of deposits and other related costs for land option contracts the Company no longer plans to pursue in its Consolidated Statements of Operations within Homebuilding expense.

     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 FASB Interpretation No. 46, “Consolidation of Variable Interest Entities,” as amended by FIN 46-R issued in December 2003 (collectively referred to as “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. Creditors of the variable interest entities have no recourse against the Company.

     In applying the provisions of FIN 46, the Company evaluated all of its land option agreements 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, 2007 and December 31, 2006, the Company classified $31.7 million and $43.6 million, respectively, as land, not owned, under option agreements on the balance sheet, representing the fair value of land under contract, including deposits of $3.3 million and $6 million, respectively. The corresponding liability has been classified within accrued and other liabilities on the balance sheet.

     Land option agreements that did not require consolidation under FIN 46 at September 30, 2007 and December 31, 2006 had a total purchase price of $2.2 billion and $4.3 billion, respectively. In connection with these agreements, the Company had refundable and non-refundable deposits and other related costs of $244 million and $363.5 million, which were included in other assets at September 30, 2007 and December 31, 2006, respectively.

     Goodwill, which represents the cost of acquired companies in excess of the fair value of the net assets at the acquisition date, was recorded in prior years in connection with various acquisitions. In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 142, the Company tests goodwill for potential impairment annually in the fourth quarter and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. Due to a significant deterioration in market conditions, a continuation of significant impairments and land-related charges, and a steep decline in the market price of the Company’s common stock to a level significantly below its book value, the Company performed a detailed evaluation of goodwill as of September 30, 2007.

     Management evaluated the recoverability of goodwill by comparing the carrying value of the Company’s reporting units to their fair value. Fair value was determined based on discounted future cash flows. These cash flows are significantly impacted by estimates related to current market valuations, current and future economic conditions in each of its geographical markets, and the Company’s strategic plans within each of its markets. Due to uncertainties in the estimation process and the significant volatility in demand for new housing, actual results could differ significantly from such estimates. Additionally, future changes in any of these factors could result in future impairments of the remaining goodwill.

     The evaluation as of September 30, 2007 resulted in an impairment charge of $335.6 million related to the following reportable segments ($000’s omitted):

     In response to the challenging operating environment that continues to exist, the Company initiated a restructuring plan during the second quarter of 2007 designed to reduce ongoing overhead costs and improve operating efficiencies. The restructuring includes the closure of selected divisional offices, the disposal of related property and equipment, and a reduction in the Company’s workforce of approximately 1,700 employees. Included below is a summary of charges incurred related to the restructuring ($000’s omitted):

     Substantially all of these costs have been included in the Consolidated Statements of Operations within Homebuilding expense. The Company expects to incur up to $50 million in total costs related to this restructuring plan, of which approximately $40 million will be cash expenditures. The majority of these cash expenditures relate to employee severance benefits and will be incurred during 2007. The remaining cash expenditures will be incurred over the remaining terms of the affected office leases, some of which continue through 2014. The restructuring costs relate to each of its reportable segments and are not material to any one segment.

     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 in 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):

     The Company has, and requires the majority of its subcontractors to have, general liability, property, errors and omissions, workers compensation and other business insurance. These insurance policies protect the Company against a portion of the risk of loss from claims, subject to certain self-insured retentions, deductibles, and other coverage limits. Through its captive insurance subsidiaries, the Company reserves for costs to cover its self-insured and deductible amounts, including any costs of claims and lawsuits, under those policies based on an analysis of its historical claims, which includes an estimate of claims incurred but not yet reported. The Company experienced net increases in insurance-related expenses of $23.2 million and $63.2 million for the three and nine months ended September 30, 2007, respectively, primarily due to the development of general liability product claims.

     In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities — Including an amendment of FASB Statement No. 115” (SFAS No. 159), which permits entities to measure various financial instruments and certain other items at fair value at specified election dates. The election must be made at initial recognition of the financial instrument, and any unrealized gains or losses must be reported at each reporting date. SFAS No. 159 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. Early adoption of the statement is allowed provided that an entity also elects to apply the provisions of SFAS No. 157 (as subsequently presented). The Company is currently reviewing the potential impact of SFAS No. 159 on its consolidated financial statements.

     In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (SFAS No. 157), which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The Company is currently reviewing the potential impact of SFAS No. 157 on its consolidated financial statements.

     In March 2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial Assets” (SFAS No. 156), which provides an approach to simplify efforts to obtain hedge-like (offset) accounting. This new Statement amends SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,” with respect to the accounting for separately recognized servicing assets and servicing liabilities. The Company adopted SFAS No. 156 effective January 1, 2007. As the Company sells its servicing rights monthly on a flow basis through fixed price servicing sales contracts, the adoption of SFAS No. 156 did not have a significant impact on the Company’s consolidated financial statements.

     The FASB has revised its guidance on SFAS No. 133 Implementation Issues as of March 2006. Several Implementation Issues were revised to reflect the issuance of SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments — an Amendment of FASB Statements No. 133 and 140” (SFAS No. 155), in February 2006. SFAS No. 155 allows any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”, to be carried at fair value in its entirety, with changes in fair value recognized in earnings. In addition, SFAS No. 155 requires that beneficial interests in securitized financial assets be analyzed to determine whether they are freestanding derivatives or contain an embedded derivative. SFAS No. 155 also eliminates a prior restriction on the types of passive derivatives that a qualifying special purpose entity is permitted to hold. SFAS No. 155 is applicable to new or modified financial instruments in fiscal years beginning after September 15, 2006, though the provisions related to fair value accounting for hybrid financial instruments can also be applied to existing instruments. The Company adopted SFAS No. 155 effective January 1, 2007. The effect of adoption was not significant.

     The Company’s Homebuilding operating segments are engaged in the acquisition and development of land primarily for residential purposes within the continental United States and the construction of housing on such land targeted for first-time, first and second move-up, and active adult home buyers.

     The Company has determined that its Homebuilding operating segments are its Areas, which are aggregated into seven reportable segments based on similarities in the economic and geographic characteristics of the Company’s homebuilding operations. During the three months ended September 30, 2007, the Company moved its Kansas City market from the Central to the Great Lakes Area. The operating data by segment for the Central and Midwest reportable segments have been reclassified to reflect this change. Accordingly, the Company’s reportable Homebuilding segments are as follows:

     The Company also has one reportable segment for its Financial Services operations, which consists principally of mortgage banking and title operations conducted through Pulte Mortgage and other Company subsidiaries. The Company’s Financial Services segment operates generally in the same markets as the Company’s Homebuilding segments.

     Evaluation of segment performance is based on operating earnings from continuing operations before provision for income taxes which, for the homebuilding operations, is defined as home sales (settlements) and land sale revenues less home cost of sales, land cost of sales and certain selling, general and administrative and other expenses, plus equity income from unconsolidated entities, which are incurred by or allocated to its Homebuilding segments. Operating earnings for the Financial Services segment is defined as revenues less costs associated with its mortgage operations and certain selling, general and administrative expenses incurred by or allocated to the Financial Services segment.

     Each reportable segment follows the same accounting policies described in Note 1 — “Summary of Significant Accounting Policies” to the consolidated financial statements in the Company’s 2006 Annual Report on Form 10-K.

The Company also recorded impairments for its investments in unconsolidated joint ventures totaling $51.1 million (relating to Southwest) and $105.2 million (of which $54.1 million was in California) in the three and nine months ended September 30, 2007, respectively.

     Total assets and inventory by reportable segment are as follows ($000’s omitted):

     Major components of the Company’s inventory are as follows ($000’s omitted):

     The Company participates in a number of joint ventures with independent third parties. Many of these joint ventures purchase, develop and/or sell land and homes in the United States and Puerto Rico. If additional capital infusions are required and approved (or are necessary as a result of the limited recourse financing guarantees discussed below), the Company would need to contribute its pro rata portion of those capital needs in order not to dilute its ownership in the joint ventures.

     At September 30, 2007 and December 31, 2006, aggregate outstanding debt of unconsolidated joint ventures was $700.5 million and $935.9 million, respectively. At September 30, 2007 and December 31, 2006, the Company’s proportionate share of its joint venture debt was approximately $185.9 million and $312.8 million, respectively. The Company provided limited recourse guarantees for $176.6 million and $304.1 million of joint venture debt at September 30, 2007 and December 31, 2006, respectively. Accordingly, the Company may be responsible, on a contingent basis, through limited guarantees with respect to a portion of the secured land acquisition and development debt. However, the Company would not be responsible unless a joint venture was unable to perform its contractual borrowing obligations.

     For the nine months ended September 30, 2007, the Company made additional capital contributions totaling $155.6 million to fund the cash requirements of existing joint ventures and received capital and earnings distributions totaling $33.4 million from existing joint ventures. At September 30, 2007 and December 31, 2006, the Company had $152.6 million and $150.7 million, respectively, invested in these joint ventures. These investments are included in the assets of the Company’s Homebuilding segments and are accounted for primarily under the equity method.

     In February 2006, Pulte Mortgage sold its investment in Hipotecaria Su Casita (“Su Casita”), a Mexico-based mortgage banking company. Remaining shareholders of Su Casita, who exercised their right of first refusal to acquire the shares, purchased Pulte Mortgage’s 16.7% interest for net proceeds of approximately $49.2 million. As a result of this transaction, the Company recognized a pre-tax gain of approximately $31.6 million for the nine months ended September 30, 2006.

     Pursuant to the two $100 million stock repurchase programs authorized by the Board of Directors in October 2002 and 2005 and the $200 million stock repurchase authorization in February 2006 (for a total stock repurchase authorization of $400 million), the Company has repurchased a total of 9,688,900 shares for a total of $297.7 million, though there were no repurchases under these programs during the nine months ended September 30, 2007. The Company had remaining authorization to purchase $102.3 million of common stock at September 30, 2007.

     Accumulated other comprehensive income (loss)

     The accumulated balances related to each component of other comprehensive income (loss) are as follows ($000’s omitted):

     The Company’s effective income tax rate for the three and nine months ended September 30, 2007 was 28% and 32.4%, respectively, compared with an effective tax rate of 35.2% and 36.6% in the corresponding prior year periods. The effective tax rates during 2007 were lower than in the prior year primarily due to the majority of the recorded goodwill impairment being non-deductible for tax purposes. Excluding the goodwill impairment charge, the effective tax rate would have been 37.3% for the nine months ended September 30, 2007.

     The Company adopted the provisions of FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (FIN 48), effective January 1, 2007. FIN 48 creates a single model to address accounting for uncertainty in tax positions and clarifies accounting for income taxes by prescribing a minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. FIN 48 also provides guidance on de-recognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition.

     The January 1, 2007 adoption of FIN 48 resulted in a $31.4 million increase in income tax liabilities and a corresponding charge to beginning retained earnings.

     As of adoption, the Company had $86.7 million of gross unrecognized tax benefits, all of which, if recognized, would affect the effective tax rate. Additionally, the Company had $24.5 million of accrued interest and $13.3 million of accrued penalties as of January 1, 2007.

     Effective in 2007, the Company recognizes interest and penalties related to unrecognized tax benefits in income tax expense. Interest related to unrecognized tax benefits was previously included in interest expense.

     The Company is currently under examination by various taxing jurisdictions and anticipates finalizing the examinations with certain jurisdictions within the next twelve months. The final outcome of these examinations is not yet determinable. The statute of limitations for the Company’s major tax jurisdictions remains open for examination for tax years 1998-2006.

     The Company repurchased $61.2 million of its 4.875% senior notes due 2009 during the nine months ended September 30, 2007. These repurchases resulted in a net gain of approximately $500 thousand which is included in the Consolidated Statements of Operations within Other non-operating, net expenses.

     On June 29, 2007, the Company amended its unsecured revolving credit facility, decreasing the borrowing availability from $2.01 billion to $1.86 billion and extending the maturity date from October 2010 to June 2012. Under the terms of the credit facility, the Company has the capacity to issue letters of credit totaling up to $1.125 billion. Borrowing availability is reduced by the amount of letters of credit outstanding. The credit facility contains certain financial covenants. The Company is required to not exceed a debt-to-total capitalization ratio of 55%, and it is also required to meet a tangible net worth minimum each quarter. The credit facility no longer contains an interest coverage ratio covenant that could create an event of default for the Company, but if the interest coverage ratio (as defined in the credit facility) is less than 2 to 1, LIBOR margin and letter of credit pricing under the credit facility increases in increments ranging from 0.125% to 0.375%. The credit facility’s uncommitted accordion feature remains unchanged at $2.25 billion.

     Pulte Mortgage reduced the amount of capacity available under its asset-backed commercial paper program from $550 million to $400 million effective June 1, 2007 as permitted by its existing agreement. Subsequently, Pulte Mortgage reduced the amount of capacity available under its asset-backed commercial paper program in September 2007 from $400 million to $300 million due to unfavorable changes in the asset-backed commercial paper market. Due to reduced origination volume, the Company does not anticipate needing any additional capacity in the near term.

     At September 30, 2007, Pulte Homes, Inc. had the following outstanding senior note obligations: (1) $339 million, 4.875% due 2009, (2) $200 million, 8.125%, due 2011, (3) $499 million, 7.875%, due 2011, (4) $300 million, 6.25%, due 2013, (5) $500 million, 5.25%, due 2014, (6) $350 million, 5.2%, due 2015, (7) $150 million, 7.625%, due 2017, (8) $300 million, 7.875%, due 2032, (9) $400 million, 6.375%, due 2033, (10) $300 million, 6%, due 2035, and (11) $150 million, 7.375%, due 2046. 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 Homebuilding subsidiaries (collectively, the Guarantors). Such guarantees are full and unconditional.

     Supplemental consolidating financial information of the Company, 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.