UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
For the quarterly period ended September 30, 2010
Commission File Number 1-9804
PULTEGROUP, INC.
(Exact name of registrant as specified in its charter)
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
100 Bloomfield Hills Parkway, Suite 300
Bloomfield 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 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 ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). YES þ NO ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). YES ¨ NO þ
Number of shares of common stock outstanding as of October 31, 2010: 382,228,225
INDEX
Item 1
Financial Statements
Condensed Consolidated Balance Sheets at September 30, 2010 and December 31, 2009
Consolidated Statements of Operations for the three and nine months ended September 30, 2010 and 2009
Consolidated Statements of Shareholders’ Equity for the three and nine months ended September 30, 2010 and 2009
Consolidated Statements of Cash Flows for the nine months ended September 30, 2010 and 2009
Notes to Condensed Consolidated Financial Statements
Item 2
Item 3
Item 4
PART II
Item 6
SIGNATURES
2
PART I. FINANCIAL INFORMATION
CONDENSED CONSOLIDATED BALANCE SHEETS
($000’s omitted)
Cash and equivalents
Restricted cash
Unfunded settlements
House and land inventory
Land held for sale
Land, not owned, under option agreements
Residential mortgage loans available-for-sale
Investments in unconsolidated entities
Goodwill
Intangible assets, net
Other assets
Income taxes receivable
Liabilities:
Accounts payable, including book overdrafts of $74,301 and $104,418 in 2010 and 2009, respectively
Customer deposits
Accrued and other liabilities
Collateralized short-term debt, recourse solely to applicable non-guarantor subsidiary assets
Income tax liabilities
Senior notes
Total liabilities
Shareholders’ equity
Note: The Condensed Consolidated Balance Sheet at December 31, 2009 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.
3
CONSOLIDATED STATEMENTS OF OPERATIONS
(000’s omitted, except per share data)
(Unaudited)
Revenues:
Homebuilding
Home sale revenues
Land sale revenues
Financial Services
Total revenues
Homebuilding Cost of Revenues:
Home cost of revenues
Land cost of revenues
Financial Services expenses
Selling, general and administrative expenses
Other expense (income), net
Interest income
Interest expense
Equity in (earnings) loss of unconsolidated entities
Loss before income taxes
Income tax expense (benefit)
Net income (loss)
Per share data:
Basic income (loss) per share
Diluted income (loss) per share
Number of shares used in calculation:
Basic
Effect of dilutive securities
Diluted
4
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
Additional
Paid-in
Accumulated
Other
Comprehensive
Income
Shareholders’ Equity, January 1, 2010
Stock option exercises
Stock awards, net of cancellations
Stock repurchases
Stock-based compensation
Comprehensive income (loss):
Change in fair value of derivatives, net of tax
Total comprehensive income (loss)
Shareholders’ Equity, September 30, 2010
Shareholders’ Equity, January 1, 2009
Stock issued for Centex merger
Consolidation of noncontrolling interests
Foreign currency translation adjustments
Total comprehensive loss
Shareholders’ Equity, September 30, 2009
5
CONSOLIDATED STATEMENTS OF CASH FLOWS
Cash flows from operating activities:
Adjustments to reconcile net income (loss) to net cash flows provided by (used in) operating activities:
Write-down of land and deposits and pre-acquisition costs
Goodwill impairments
Amortization and depreciation
Stock-based compensation expense
Distributions of earnings from unconsolidated entities
Loss on debt repurchases
Other, net
Increase (decrease) in cash due to:
Inventories
Accounts payable, accrued and other liabilities
Net cash provided by (used in) operating activities
Cash flows from investing activities:
Distributions from unconsolidated entities
Cash acquired with Centex merger, net of cash used
Net change in loans held for investment
Proceeds from the sale of fixed assets
Capital expenditures
Net cash provided by (used in) investing activities
Cash flows from financing activities:
Net (repayments) borrowings under Financial Services credit arrangements
Net repayments of other borrowings
Issuance of common stock
Net cash provided by (used in) financing activities
Effect of exchange rate changes on cash and equivalents
Net increase (decrease) in cash and equivalents
Cash and equivalents at beginning of period
Cash and equivalents at end of period
Supplemental Cash Flow Information:
Interest paid, net of amounts capitalized
Income taxes paid (refunded), net
6
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Basis of presentation
On March 18, 2010, Pulte Homes, Inc. changed its name to PulteGroup, Inc. (“PulteGroup”). The consolidated financial statements include the accounts of PulteGroup 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 PulteGroup, Inc. include Pulte Diversified Companies, Inc., Del Webb Corporation (“Del Webb”), Centex Corporation (“Centex”), and other subsidiaries that are engaged in the homebuilding business. The Company also has mortgage banking operations, conducted principally through Pulte Mortgage LLC (“Pulte Mortgage”), and title operations.
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 adjustments) considered necessary for a fair presentation have been included. Operating results for the nine months ended September 30, 2010 are not necessarily indicative of the results that may be expected for the year ending December 31, 2010. 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, 2009.
On August 18, 2009, the Company completed the acquisition of Centex through the merger of PulteGroup’s merger subsidiary with and into Centex pursuant to the Agreement and Plan of Merger dated as of April 7, 2009 among PulteGroup, Pi Nevada Building Company, and Centex. As a result of the merger, Centex became a wholly-owned subsidiary of PulteGroup. Accordingly, the results of Centex are included in the Company’s consolidated financial statements from the date of the merger.
Reclassifications
Certain prior period amounts have been reclassified to conform to the current year presentation.
Subsequent events
The Company evaluated subsequent events up until the time the financial statements were filed with the Securities and Exchange Commission.
Other expense (income), net as reflected in the Consolidated Statements of Operations consists of the following ($000’s omitted):
Write-off of deposits and pre-acquisition costs
Lease exit and related costs
Amortization of intangible assets
Loss on debt retirements
Miscellaneous expense (income), net
7
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
Earnings per share
Basic earnings per share is computed by dividing income (loss) 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. For the three and nine months ended September 30, 2010 and 2009, 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 periods.
Under Accounting Standards Codification (“ASC”) 260, “Earnings Per Share,” unvested share-based payment awards that contain non-forfeitable rights to dividends or dividend equivalents are participating securities and, therefore, are included in computing earnings per share pursuant to the two-class method. The two-class method determines earnings per share for each class of common stock and participating securities according to dividends or dividend equivalents and their respective participation rights in undistributed earnings. Although the Company’s outstanding restricted stock and restricted stock units are considered participating securities under the ASC, there were no earnings attributable to restricted shareholders during the three and nine months ended September 30, 2010 or 2009.
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 generally provides a deposit to the seller as consideration for the right to purchase land at different times in the future, usually at predetermined prices. Under ASC 810, “Consolidation” (“ASC 810”), if the entity holding the land under option is a variable interest entity (“VIE”), the Company’s deposit represents a variable interest in that entity. If the Company is determined to be the primary beneficiary of the VIE, then the Company is required to consolidate the VIE, though creditors of the VIE have no recourse against the Company.
In applying the provisions of ASC 810, the Company evaluates all land option agreements with VIEs to determine whether the Company is the primary beneficiary. The Company generally has little control or influence over the operations of these VIEs due to the Company’s lack of an equity interest in them. Therefore, when the Company’s requests for financial information are denied, the Company is required to make certain assumptions about the assets, liabilities, and financing of such entities. The VIE is generally protected from the first dollar of loss under the Company’s land option agreement due to the Company’s deposit. Likewise, the VIE’s gains are generally capped based on the purchase price within the land option agreement. The Company’s maximum exposure to loss related to these VIEs is limited to the Company’s deposits and pre-acquisition costs under the applicable land option agreements. In recent years, the Company has canceled a significant number of land option agreements, which has resulted in significant write-offs of the related deposits and pre-acquisition costs but has not exposed the Company to the overall risks or losses of the applicable VIEs.
Generally, financial statements for the VIEs are not available. As a result, for VIEs the Company is required to consolidate, the Company records the remaining contractual purchase price under the applicable land option agreement to land, not owned, under option agreements with an offsetting increase to accrued and other liabilities. Consolidation of these VIEs has no impact on the Company’s results of operations or cash flows. At December 31, 2009, the Company determined that it was subject to a majority of the expected losses or entitled to receive a majority of the expected residual returns under six of these agreements with scheduled expiration dates through 2010 and consolidated $47.1 million as land, not owned, under option agreements with the corresponding liability classified within accrued and other liabilities. Upon the adoption of ASU 2009-17, “Amendments to FASB Interpretation No. 46(R),” which became effective January 1, 2010, the Company determined that it did not have power to direct the most significant activities of these VIEs and, therefore, de-consolidated them. The Company did not provide financial or other support to any VIEs other than as stipulated in the land option agreements.
8
Land, not owned, under option agreements (continued)
In addition to land option agreements consolidated under ASC 810, the Company determined that certain land option agreements represent financing arrangements pursuant to ASC 470-40, “Accounting for Product Financing Arrangements” (“ASC 470-40”), even though the Company has no direct obligation to pay these future amounts. As a result, the Company recorded $62.4 million and $127.1 million at September 30, 2010 and December 31, 2009, respectively, to land, not owned, under option agreements with a corresponding increase to accrued and other liabilities. Such amounts represent the remaining purchase price under the land option agreements in the event the Company exercises the purchase rights under the agreements.
The following provides a summary of the Company’s interests in land option agreements as of September 30, 2010 and December 31, 2009 ($000’s omitted):
Consolidated VIEs
Unconsolidated VIEs
Other land option agreements
The above summary includes land option agreements consolidated under ASC 810 and ASC 470-40 as well as all other land option agreements. The remaining purchase price (total purchase price less deposit) of all land option agreements totaled $699.5 million at September 30, 2010 and $599.8 million at December 31, 2009.
9
Allowance for warranties
Home purchasers are provided with a limited warranty against certain building defects, including a one- to two-year comprehensive limited warranty as well as coverage for certain other aspects of the home’s construction and operating systems for periods 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 the cost per claim. The Company periodically assesses the adequacy of its recorded warranty liability for each geographic market in which the Company operates and adjusts the amounts as necessary. Actual warranty costs in the future could differ from the current estimates. Changes to the Company’s warranty liability were as follows ($000’s omitted):
Warranty liability, beginning of period
Warranty reserves provided
Liabilities assumed with Centex merger
Payments
Other adjustments
Warranty liability, end of period
Substantially all of the loans originated by the Company are sold in the secondary mortgage market within a short period of time after origination. In accordance with ASC 825, “Financial Instruments,” the Company has elected the fair value option for its portfolio loans available-for-sale. Election of the fair value option for residential mortgage loans available-for-sale allows a better offset of the changes in fair values of the loans and the derivative instruments used to economically hedge them without having to apply complex hedge accounting provisions. The Company does not designate any derivative instruments or apply the hedge accounting provisions of ASC 815, “Derivatives and Hedging.” Fair values for conventional agency residential mortgage loans available-for-sale are determined based on quoted market prices for comparable instruments. Fair values for government and non-agency residential mortgage loans available-for-sale are determined based on purchase commitments from whole loan investors and other relevant market information available to management. At September 30, 2010 and December 31, 2009, residential mortgage loans available-for-sale had an aggregate fair value of $153.8 million and $166.8 million, respectively, and an aggregate outstanding principal balance of $148.6 million and $166.4 million, respectively. The net gain (loss) resulting from changes in fair value of these loans totaled $(0.9) million and $(3.2) million for the three months ended September 30, 2010 and 2009, respectively, and $1.0 million and $(4.0) million for the nine months ended September 30, 2010 and 2009, respectively, and are included in Financial Services revenues. These changes in fair value were mostly offset by changes in fair value of the corresponding hedging instruments. Net gains from the sale of mortgages were $15.6 million and $18.7 million during the three months ended September 30, 2010 and 2009, respectively, and $50.7 million and $40.7 million for the nine months ended September 30, 2010 and 2009, respectively, and are included in Financial Services revenues.
Mortgage servicing rights
The Company sells its servicing rights monthly on a flow basis through fixed price servicing contracts. In accordance with Staff Accounting Bulletin No. 109, the Company recognizes the fair value of its rights to service a mortgage loan as revenue at the time of entering into an interest rate lock commitment with a borrower. Due to the short period of time the servicing rights are held, the Company does not amortize the servicing asset. The servicing sales contracts provide for the reimbursement of payments made by the purchaser if loans prepay within specified periods of time, generally within 90 to 120 days after sale. The Company establishes reserves for this liability at the time the sale is recorded. Such reserves totaled $0.5 million and $1.8 million at September 30, 2010 and December 31, 2009, respectively, and are included in accrued and other liabilities. Servicing rights recognized in Financial Services revenues totaled $4.2 million and $11.7 million during the three months ended September 30, 2010 and 2009, respectively, and $17.0 million and $18.9 million during the nine months ended September 30, 2010 and 2009, respectively.
10
Derivative instruments and hedging activities
The Company is exposed to market risks from commitments to lend, movements in interest rates, and cancelled or modified commitments to lend. A commitment to lend at a specific interest rate (an interest rate lock commitment) is a derivative financial instrument (interest rate is locked to the borrower). In order to reduce these risks, the Company uses other derivative financial instruments to economically hedge the interest rate lock commitment. These financial instruments can include cash forward placement contracts on mortgage-backed securities, whole loan investor commitments, options on treasury futures contracts, and options on cash forward placement contracts on mortgage-backed securities. The Company does not use any derivative financial instruments for trading purposes. The Company enters into one of the aforementioned derivative financial instruments upon accepting interest rate lock commitments. The changes in the fair value of the interest rate lock commitment and the other derivative financial instruments are recognized in current period earnings and the fair value is reflected in other assets or other liabilities in the Condensed Consolidated Balance Sheets. The gains and losses are included in Financial Services revenues.
Fair values for interest rate lock commitments, including the value of servicing rights, are based on market prices for similar instruments. At September 30, 2010 and December 31, 2009, the Company had interest rate lock commitments in the amount of $199.9 million and $126.9 million, respectively, which were originated at interest rates prevailing at the date of commitment. Since the Company can terminate a loan commitment if the borrower does not comply with the terms of the contract, and some loan commitments may expire without being drawn upon, these commitments do not necessarily represent future cash requirements of the Company. The Company evaluates the creditworthiness of these transactions through its normal credit policies.
Cash forward placement contracts on mortgage-backed securities are commitments to either purchase or sell a specified financial instrument at a specified future date for a specified price and may be settled in cash, by offsetting the position, or through the delivery of the financial instrument. Whole loan investor commitments are obligations of the investor to buy loans at a specified price within a specified time period. Mandatory cash forward contracts on mortgage-backed securities are the predominant derivative financial instruments used to minimize the market risk during the period from the time the Company extends an interest rate lock to a loan applicant until the time the loan is sold to an investor. Forward contracts are valued based on market prices for similar instruments. Fair values for whole loan commitments are based on market prices for similar instruments from the specific whole loan investor. At September 30, 2010, the Company had unexpired cash forward contracts and whole loan investor commitments of $269.4 million and $46.2 million, respectively, compared with cash forward contracts and whole loan investor commitments of $257.9 million and $23.8 million, respectively, at December 31, 2009.
There are no credit-risk-related contingent features within the Company’s derivative agreements. Gains and losses on interest rate lock commitments are offset by corresponding gains or losses on forward contracts and whole loan commitments. At September 30, 2010, the maximum length of time that the Company was exposed to the variability in future cash flows of derivative instruments was approximately 75 days.
The fair value of the Company’s derivative instruments and their location in the Condensed Consolidated Balance Sheet is summarized below ($000’s omitted):
Interest rate lock commitments
Forward contracts
Whole loan commitments
11
New accounting pronouncements
In June 2009, the FASB issued SFAS No. 166, “Accounting for Transfers of Financial Assets; an amendment of FASB Statement No. 140,” (codified in “ASC 860”). ASC 860 requires enhanced disclosures regarding transfers of financial assets and continuing exposure to the related risks. ASC 860 also eliminates the concept of a qualifying special-purpose entity and changes the requirements for derecognizing financial assets. The Company adopted ASC 860 as of January 1, 2010, which did not have a material impact on the Company’s financial statements.
In June 2009, the FASB issued SFAS No. 167, “Amendments to FASB Interpretation No. 46(R),” (codified in “ASU 2009-17”). ASU 2009-17 amended the consolidation guidance for VIEs, requires ongoing reassessment to determine whether a VIE must be consolidated, and requires additional disclosures regarding involvement with variable interest entities and any significant changes in risk exposure due to that involvement. The Company adopted ASU 2009-17 as of January 1, 2010. As a result of the adoption, the Company de-consolidated six VIEs that were consolidated at December 31, 2009, which reduced land, not owned, under option agreements and accrued and other liabilities in the Consolidated Balance Sheets by $47.1 million.
In January 2010, the FASB issued Accounting Standards Update No. 2010-06, “Improving Disclosures about Fair Value Measurements” (“ASU 2010-06”), amending ASC 820 to increase disclosure requirements regarding recurring and nonrecurring fair value measurements. The Company adopted ASU 2010-06 as of January 1, 2010, except for the disclosures about activity in Level 3 fair value measurements which will be effective for the Company’s fiscal year beginning January 1, 2011. The adoption of ASC 820 did not have a material impact on the Company’s financial statements and is not expected to have a material impact on the Company’s financial statements once fully implemented.
In March 2010, the FASB issued ASU 2010-09, “Subsequent Events (Topic 855) – Amendments to Certain Recognition and Disclosure Requirements.” This update removes the requirements for an SEC filer to disclose a date through which subsequent events are evaluated in both issued and revised financial statements, alleviating potential conflicts with the SEC’s requirements. ASU 2010-09 was effective for the Company upon issuance. The adoption did not impact the Company’s financial statements.
12
On August 18, 2009, the Company completed the acquisition of Centex through the merger of PulteGroup’s merger subsidiary with and into Centex pursuant to the Agreement and Plan of Merger dated as of April 7, 2009 among PulteGroup, Pi Nevada Building Company, and Centex (the “Merger Agreement”). As a result of the merger, Centex became a wholly-owned subsidiary of PulteGroup. Accordingly, the results of Centex are included in the Company’s consolidated financial statements from the date of the merger.
Pursuant to the terms and conditions of the Merger Agreement, PulteGroup acquired all of the outstanding shares of Centex common stock at the fixed exchange ratio of 0.975 shares of PulteGroup common stock for each share of Centex common stock. In addition, the majority of the restricted shares of Centex common stock and restricted stock units with respect to Centex common stock granted under Centex’s employee and director stock plans vested and were converted per the exchange ratio into PulteGroup common stock or units with respect to PulteGroup common stock. Each outstanding vested and unvested Centex stock option granted under Centex’s employee and director stock plans was converted into a vested option to purchase shares of PulteGroup common stock, with adjustments to reflect the exchange ratio.
The Merger Agreement required that, with respect to Centex stock options that were granted with an exercise price less than $40.00 per share, the terms of the converted, vested options to purchase shares of PulteGroup common stock provided that, if the holder of the option experiences a severance-qualifying termination of employment during the two-year period following the completion of the merger, the stock option remained exercisable until the later of (1) the third anniversary of the date of the termination of employment and (2) the date on which the option would cease to be exercisable in accordance with its terms (or, in either case, if earlier, the expiration of the scheduled term of the option). This provision will result in an immaterial amount of incremental expense in the post-merger period.
The Centex merger was accounted for in accordance with ASC 805, “Business Combinations”. For accounting purposes, PulteGroup was treated as the acquirer, and the consideration transferred was computed based on PulteGroup’s common stock closing price of $12.33 per share on August 18, 2009, the date the merger was consummated. The acquired assets and assumed liabilities were recorded by PulteGroup at their estimated fair values, with certain limited exceptions. PulteGroup determined the estimated fair values with the assistance of appraisals or valuations performed by independent third party specialists, discounted cash flow analyses, quoted market prices where available, and estimates made by management. To the extent the consideration transferred exceeded the fair value of net assets acquired, such excess was assigned to goodwill.
13
The following table summarizes the calculation of the fair value of the total consideration transferred and the amounts recognized as of the acquisition date (000’s omitted, except per share data):
Calculation of consideration transferred
Centex common shares exchanged (including restricted stock)
Centex restricted stock units exchanged
Exchange ratio
PulteGroup common shares and restricted stock units issued
Closing price per share of PulteGroup common stock, as of August 18, 2009
Consideration attributable to common stock
Consideration attributable to PulteGroup equity awards exchanged for Centex equity awards (a)
Cash paid for fractional shares
Total consideration transferred
Assets acquired and liabilities assumed
Inventory
Residential mortgage loans available-for sale
Intangible assets
Goodwill (b)
Total assets acquired
Accounts payable
Total liabilities assumed
Total net assets acquired
Cash and equivalents, other assets, accounts payable, and accrued and other liabilities were generally stated at historical carrying values given the short-term nature of these assets and liabilities. Because Centex had elected the fair value option under ASC 825 for its residential mortgage loans available-for-sale, the historical carrying value of such assets equaled their fair value. Income tax receivables and liabilities were recorded at historical carrying values in accordance with ASC 805. The fair value of assumed senior notes was determined based on quoted market prices.
The Company determined the fair value of inventory on a community-by-community basis primarily using a combination of market comparable land transactions, where available, and discounted cash flow models, though independent appraisals were also utilized in certain instances. These estimated cash flows are significantly impacted by estimates related to expected average selling prices and sales incentives, expected sales paces and cancellation rates, expected land development and 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. See Note 5 for additional discussion of the factors impacting the fair value of land inventory.
14
The fair values for acquired intangible assets were determined based on valuations performed by independent valuation specialists. Of the $100.0 million of acquired intangible assets, $96.0 million related to tradenames that will generally be amortized over 20 years. Amortization expense for these assets totaled $1.2 million and $3.7 million for the three and nine months ended September 30, 2010, respectively, and is included in the Consolidated Statements of Operations within other expense (income), net. The remaining $4.0 million of acquired intangible assets related to acquired backlog at August 18, 2009 and was amortized in 2009 as the related customer orders closed.
During the three months ended June 30, 2010, the Company completed its business combination accounting. This resulted in an increase to goodwill of $2.5 million related to the completion of a final valuation of self-insurance liabilities assumed with the Centex merger.
As of the merger date, goodwill largely consisted of the expected economic value attributable to Centex’s deferred tax assets and expected synergies resulting from the merger. Centex had $1.3 billion of deferred tax assets as of the merger date, which were substantially offset by a valuation allowance due to the uncertainty of realization. While the ultimate realization of these deferred tax assets is dependent upon the generation of taxable income during future periods, such assets have a significant economic value given their long life and the Company’s expectations regarding future operating results. As discussed in Note 9, a portion of the economic value of these deferred tax assets was recognized in the fourth quarter of 2009. The combined entity has also achieved significant savings in corporate and divisional overhead costs and interest costs and synergies in the areas of purchasing leverage and integrating the combined organization’s operational best practices. The Company also anticipates opportunities for growth through expanded geographic and customer segment diversity and the ability to leverage additional brands.
Transaction and integration costs
Transaction and integration costs directly related to the Centex merger, excluding the impact of restructuring costs and acquisition accounting adjustments, totaled $31.9 million and $37.6 million for the three and nine months ended September 30, 2009, the majority of which are included in the Consolidated Statements of Operations within selling, general and administrative expenses. Such costs were expensed as incurred in accordance with ASC 805. See Note 4 for a discussion of restructuring costs incurred in connection the Centex merger.
Supplemental pro forma information
The following represents pro forma operating results as if Centex had been included in the Company’s Condensed Consolidated Statements of Operations as of January 1, 2009 ($000’s omitted, except per share data):
Revenue
Net loss
Loss per common share - basic and diluted
The supplemental pro forma operating results have been determined after adjusting the operating results of Centex to reflect additional amortization that would have been recorded assuming the fair value adjustments to intangible assets had been applied as of January 1, 2009. Certain other adjustments, including those related to conforming accounting policies and adjusting acquired inventory to fair value, have not been reflected in the supplemental pro forma operating results due to the impracticability of estimating such impacts. Additionally, given the significant volatility in the homebuilding industry in recent periods, such a presentation would not be indicative of future operating results.
15
Goodwill, which represents the cost of acquired companies in excess of the fair value of the net assets at the acquisition date, has been recorded in connection with various acquisitions and is subject to annual impairment testing in the fourth quarter of each year or when events or changes in circumstances indicate the carrying amount may not be recoverable. As further explained in Note 2, the Company recorded $1.5 billion of goodwill in connection with the Centex merger. All goodwill associated with prior transactions has been previously written-off. In accordance with ASC 350, management evaluates the recoverability of goodwill by comparing the carrying value of the Company’s reporting units to their fair value. Fair value is determined using accepted valuation methods, including the use of discounted cash flows supplemented by market-based assessments of fair value. Impairment is measured as the difference between the resulting implied fair value of goodwill and its recorded carrying value. The determination of fair value is significantly impacted by estimates related to current market valuations, current and future economic conditions in each of the Company’s geographical markets, and the Company’s strategic plans within each of its markets. Due to uncertainties in the estimation process and significant volatility in demand for new housing, actual results could differ significantly from such estimates.
During the fourth quarter of 2009, the Company performed its annual goodwill impairment test. The determinations of fair value in allocating goodwill at the Centex merger date (August 18, 2009) and at the goodwill impairment assessment date (October 31, 2009) followed the same process using similar long-term assumptions. The primary difference was that the valuation at the merger date was based on only the acquired Centex operations reconciled to the purchase price for the Centex merger while the valuation at the assessment date was based on the integrated operations of each reporting unit reconciled to the Company’s overall market capitalization. This valuation approach at the assessment date was consistent with the Company’s operating structure following the merger in that all acquired Centex operations were integrated with the Pulte operations and managed and forecasted at the local market level, not according to legacy operations.
As a result of the goodwill impairment test as of October 31, 2009, the Company determined that $563.0 million of goodwill was impaired. This impairment resulted from a number of factors, including:
a significant decline in the Company’s overall market capitalization between the Centex merger date and the goodwill assessment date, which implied that the fair values of the Company’s reporting units had decreased;
the requirement under ASC 350 to allocate all goodwill to the Company’s reporting units even though a significant portion of the goodwill is attributable to the economic value of deferred tax assets and corporate and financing synergies that are not directly reflected in the fair values of the individual reporting units; and
the relationship of the Company’s market capitalization to the Company’s stockholders’ equity, which were approximately equal. This implied that some reporting units would likely have an excess of fair value above carrying value while others would have a deficiency, which is consistent with the impairment results.
As explained in Note 2, the Company recorded an increase of $2.5 million to goodwill in the three months ended June 30, 2010 in conjunction with completing its business combination accounting for the Centex merger. As a result, the Company reperformed the fourth quarter 2009 goodwill impairment test using the revised goodwill figure and recorded an additional impairment of $1.4 million. The Company recorded the impairment in other expense (income), net in the Consolidated Statement of Operations for the nine months ended September 30, 2010. The Company also disposed of $1.6 million of goodwill in connection with the sale of the retail title operations acquired with the Centex merger.
The Company performed an event-driven assessment of the recoverability of goodwill as of September 30, 2010 following deterioration in market conditions, the Company’s operating results falling below previously forecasted levels, including an operating loss in the third quarter, certain actions taken to better align the Company’s overhead structure with lower revenue volumes, and a sustained decline in the Company’s market capitalization. In performing the goodwill impairment analysis, the Company followed a similar approach as in 2009 using management’s best estimates of the future cash flows for each reporting unit. The decline in the Company’s market capitalization occurred in spite of an increase in the Company’s tangible book value since the previous goodwill assessment as of October 31, 2009. The increase in the Company’s tangible book value resulted primarily from income tax refunds and other tax-related matters. Accordingly, the implied fair value of the Company’s homebuilding business experienced an even more significant decline than the Company’s market capitalization. The combination of these factors resulted in a goodwill impairment charge of $654.9 million, which was recorded in other expense (income), net in the Consolidated Statement of Operations for the three months ended September 30, 2010.
16
In addition to the event-driven assessment of goodwill at September 30, 2010, the Company will perform its annual assessment of the recoverability of goodwill as of October 31, 2010. If management’s expectations of future results and cash flows for any of its reporting units decrease, goodwill may be further impaired. Also, while not directly triggering an impairment of goodwill, a significant decrease in the Company’s market capitalization in the future may indicate that the fair value of one or more of the Company’s reporting units has decreased, which may result in an impairment of goodwill. Of the Company’s remaining goodwill of $240.5 million at September 30, 2010, $228.0 million relates to reporting units that are at increased risk of future impairment. Management will continue to monitor these reporting units and perform goodwill impairment testing when events or changes in circumstances indicate the carrying amount may not be recoverable.
The following summarizes the change in goodwill during 2010 ($000’s omitted):
Reporting Segment
Northeast
Southeast
Gulf Coast
Midwest
Southwest
West
Total goodwill
The Company has taken a series of actions both in response to the challenging operating environment and in connection with the Centex merger that were designed to reduce ongoing operating costs and improve operating efficiencies. As a result of the combination of these actions, the Company incurred total restructuring charges as summarized below ($000’s omitted):
Employee severance benefits
Lease exit costs
Total restructuring charges
Financial Services expenses for the three and nine months ended September 30, 2010 include $1.7 million and $3.2 million, respectively, of total restructuring charges. All other employee severance benefits are included within selling, general and administrative expense while all other lease exit and other costs are included in other expense (income), net in the Consolidated Statements of Operations. The remaining liabilities for employee severance benefits and exited leases totaled $5.4 million and $28.3 million, respectively, at September 30, 2010 and $14.2 million and $38.6 million, respectively, at December 31, 2009. Substantially all of the employee severance benefits will be paid within the next year, while cash expenditures related to lease exit costs will be incurred over the remaining terms of the applicable office leases, which generally extend several years. The restructuring costs relate to each of the Company’s reportable segments and were not material to any one segment.
17
Major components of the Company’s inventory were as follows ($000’s omitted):
Homes under construction
Land under development
Land held for future development
The Company capitalizes interest cost into inventory during the active development and construction of the Company’s communities. Each layer of capitalized interest is amortized over a period that approximates the average life of communities under development. Interest expense is allocated over the period based on the cyclical timing of unit settlements. Interest expensed to Homebuilding cost of revenues for the three and nine months ended September 30, 2010 included $7.6 million and $13.8 million, respectively, of capitalized interest related to land and community valuation adjustments compared with $15.1 million and $57.0 million, respectively for the three and nine months ended September 30, 2009. The level of the Company’s active inventory was lower than the Company’s debt level at September 30, 2010. Accordingly, $0.9 million and $1.5 million of Homebuilding interest costs were expensed directly to interest expense in the three and nine months ended September 30, 2010, respectively.
Information related to interest capitalized into homebuilding inventory is as follows ($000’s omitted):
Interest in inventory, beginning of period
Interest capitalized
Interest expensed
Interest in inventory, end of period
Homebuilding interest incurred*
18
Land Valuation Adjustments and Write-Offs
Land and community valuation adjustments
In accordance with ASC 360, “Property, Plant, and Equipment” (“ASC 360”), 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 weak market conditions throughout the homebuilding industry in recent years have resulted in lower than expected revenues and gross margins. 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 ASC 360, the Company compared the expected undiscounted cash flows for these communities to their carrying values. For those communities whose carrying values exceeded the expected undiscounted cash flows, the Company calculated the fair value of the community in accordance with ASC 360. Impairment charges are required to be recorded if the fair value of the community’s inventory is less than its carrying value.
The Company determines the fair value of a community’s inventory primarily using a combination of market comparable land transactions, where available, and discounted cash flow models. These estimated cash flows are significantly impacted by estimates related to expected average selling prices and sales incentives, expected sales paces and cancellation rates, expected land development and 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. The assumptions used in the discounted cash flow models are specific to each community tested for impairment and typically do not assume improvements in market conditions except in the latter years of long-lived 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 each of 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.
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The table below provides, as of the date indicated, the number of communities in which the Company recognized impairment charges, the fair value of those communities at such date (net of impairment charges), and the amount of impairment charges recognized ($ in millions):
Quarter Ended
March 31
June 30
September 30
The Company recorded these valuation adjustments in its Consolidated Statements of Operations within Homebuilding home cost of revenues. During the three months ended September 30, 2010, the Company reviewed each of its land positions for potential impairment indicators and performed detailed impairment calculations for approximately 50 communities. The discount rate used in the Company’s determination of fair value for the impaired communities ranged from 12% to 21%, with an aggregate average of 14%. If conditions in the homebuilding industry or the Company’s local markets worsen in the future, the current difficult market conditions extend beyond the Company’s expectations, or the Company’s strategy related to certain communities changes, the Company may be required to evaluate its assets, including additional projects, for future impairments or write-downs, which could result in future charges that might be significant.
Net realizable value adjustments – land held for sale
The Company acquires land primarily for the construction of homes for sale to customers but periodically sells select parcels of land to third parties for commercial or other development. Additionally, the Company may determine that certain of its land assets no longer fit into its strategic operating plans. In such instances, the Company classifies the land asset as land held for sale, assuming the criteria in ASC 360 are met.
In accordance with ASC 360, the Company values land held for sale at the lower of carrying value or fair value less costs to sell. In determining the fair value of land held for sale, the Company considers recent legitimate offers received, prices for land in recent comparable sales transactions, and other factors. As a result of changing market conditions in the real estate industry, a portion of the Company’s land held for sale was adjusted to net realizable value. During the three months ended September 30, 2010 and 2009, the Company recognized net realizable value adjustments related to land held for sale of $0.6 million and $8.3 million, respectively, and $1.0 million and $16.2 million for the nine months ended September 30, 2010 and 2009, respectively. The Company records these net realizable value adjustments in its Consolidated Statements of Operations within Homebuilding land cost of revenues.
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The Company’s land held for sale was as follows ($000’s omitted):
Land held for sale, gross
Net realizable value reserves
Land held for sale, net
From time to time, the Company writes off certain deposits and pre-acquisition 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 (net of recoveries) deposits and pre-acquisition costs in the amount of $1.1 million and $17.2 million during the three months ended September 30, 2010 and 2009, respectively, and $4.0 million and $18.2 million for the nine months ended September 30, 2010 and 2009, respectively. The Company records these write-offs of deposits and pre-acquisition costs in its Consolidated Statements of Operations within other expense (income), net.
21
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. In the third quarter of 2009, in connection with the Centex merger, the Company realigned the organizational structure for certain of its markets. The operating data by segment provided in this note have been reclassified to conform to the current presentation. Accordingly, the Company’s reportable Homebuilding segments are located in the following geographies:
Connecticut, Delaware, Maryland, Massachusetts, New Jersey,
New York, Pennsylvania, Rhode Island, Virginia, District of Columbia
The Company also has one reportable segment for its financial services operations, which consist principally of mortgage banking and title operations. 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 segments, is defined as home sales (settlements) and land sale revenues less home cost of revenues, land cost of revenues, and certain selling, general, and administrative and other expenses, plus equity income from unconsolidated entities, which are incurred by or allocated to the Homebuilding segments. Operating earnings for the Financial Services segment is defined as revenues less costs associated with the Company’s mortgage and title operations and certain selling, general, and administrative expenses incurred by or allocated to the Financial Services segment. Each reportable segment generally follows the same accounting policies described in Note 1 – “Summary of Significant Accounting Policies” to the consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009.
22
Other homebuilding (a)
Consolidated revenues
Income (loss) before income taxes:
Financial Services (b)
Total segment income (loss) before income taxes
Other non-operating (c)
Consolidated loss before income taxes
23
Land and community valuation adjustments:
Net realizable value adjustments (NRV) - land held for sale:
Write-off of deposits and pre-acquisition costs (b):
Impairments of investments in unconsolidated joint ventures:
Other homebuilding
Total valuation adjustments and write-offs
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Total assets and inventory by reportable segment were as follows ($000’s omitted):
Other non-operating (b)
25
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. A summary of the Company’s joint ventures is presented below ($000’s omitted):
Investments in joint ventures with limited recourse guaranties
Investments in joint ventures with debt non-recourse to Pulte
Investments in other joint ventures
Total investments in unconsolidated entities
Total joint venture debt
Pulte’s proportionate share of joint venture debt:
Joint venture debt with limited recourse guaranties
Joint venture debt non-recourse to Pulte
Pulte’s total proportionate share of joint venture debt
During the three and nine months ended September 30, 2010, the Company recognized income (loss) from its unconsolidated joint ventures of $(3.7) million and $1.7 million, respectively, including impairments of $1.9 million for the nine months ended September 30, 2010. During the three and nine months ended September 30, 2009, the Company recognized a loss from its unconsolidated joint ventures of $4.2 million and $57.2 million, respectively, including impairments totaling $5.8 million and $58.6 million, respectively. During the nine months ended September 30, 2010 and 2009, the Company made capital contributions of $22.7 million and $28.5 million, respectively, to its joint ventures and received capital and earnings distributions of $7.4 million and $4.3 million, respectively, from its joint ventures.
The timing of cash obligations under the joint venture and related financing agreements varies by agreement and in certain instances is contingent upon the joint venture’s sale of its land holdings. If additional capital infusions are required and approved, 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. While future capital contributions may be required, the Company believes the total amount of such contributions will be limited. The Company’s maximum financial loss exposure related to joint ventures is unlikely to exceed the combined investment and limited recourse guaranty totals.
A terminated joint venture financing agreement required the Company and other members of one joint venture to guaranty for the benefit of the lender the completion of the project if the joint venture did not perform the required development and an increment of interest in certain circumstances. This joint venture defaulted under its debt agreement, and the lender has foreclosed on the joint venture’s property that served as collateral. During 2008, the lender also filed suit against the majority of the members of the joint venture, including the Company, in an effort to enforce the completion guaranty. While the Company believes it has meritorious defenses against the lawsuit, there is no assurance that the Company will not be required to pay damages under the completion guaranty. The Company’s maximum exposure should be limited to its proportionate share of the amount, if any, determined to be owed under such guaranties. Accordingly, the amount of any potential loss the Company might incur as a result of resolving this matter should not exceed the Company’s proportionate share of the joint venture’s outstanding principal plus accumulated interest as of the date the lender foreclosed on the property, the Company’s proportionate share of which totaled approximately $52.2 million, representing 12% of the total pre-foreclosure exposure of the joint venture, and which is excluded from the above table.
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Additionally, the Company has agreed to indemnify the lenders for a joint venture with limited recourse guaranties for certain environmental contingencies, and the guaranty arrangement provides that the Company is responsible for a proportionate share of the outstanding debt if the joint venture voluntarily files for bankruptcy. The Company would not be responsible under this guaranty unless the joint venture was unable to meet its contractual borrowing obligations or in instances of fraud, misrepresentation, or other bad faith actions by the Company. To date, the Company has not been requested to perform under the bankruptcy or environmental guaranties described above.
In addition to the joint ventures with limited recourse guaranties, the Company has investments in other unconsolidated entities, some of which have debt. These investments include the Company’s joint ventures in Puerto Rico, which are in the liquidation stage, as well as other entities. The Company does not have any significant financing exposures related to these entities.
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 program authorized 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 three months ended September 30, 2010. The Company had remaining authorization to purchase $102.3 million of common stock at September 30, 2010.
Under its stock-based compensation plans, the Company accepts shares as payment under certain conditions related to stock option exercises and vesting of restricted stock, generally related to the payment of minimum tax obligations. During the nine months ended September 30, 2010 and 2009, the Company repurchased $3.1 million and $6.5 million, respectively, of shares from employees under these plans. Such repurchases are excluded from the $400 million stock repurchase authorization.
Accumulated other comprehensive income (loss)
The accumulated balances related to each component of other comprehensive income (loss) are as follows ($000’s omitted):
Foreign currency translation adjustments:
Mexico
Fair value of derivatives, net of income taxes of $2,086 in 2010 and 2009
27
The Company’s income tax expense (benefit) was $(28.7) million and $2.7 million for the three months ended September 30, 2010 and 2009, respectively, and $(112.8) million and $7.8 million for the nine months ended September 30, 2010 and 2009, respectively. Due to the effects of the deferred tax valuation allowance and changes in unrecognized tax benefits, the Company’s effective tax rates in 2010 and 2009 are not meaningful as the income tax expense (benefit) is not directly correlated to the amount of pretax income (loss). The income tax benefit for the nine months ended September 30, 2010 was primarily due to the favorable resolution of certain federal and state income tax matters.
The Company had income taxes receivable of $136.8 million and $955.2 million at September 30, 2010 and December 31, 2009, respectively. Income taxes receivable at December 31, 2009 related primarily to the carryback of 2009 federal net operating losses under the Worker, Homeownership, and Business Assistance Act of 2009 (the “Act”), which was enacted into law on November 6, 2009. The Act amended Section 172 of the Internal Revenue Code to allow net operating losses realized in either tax year 2008 or 2009 to be carried back up to five years (previously limited to two years). The Company received federal income tax refunds of $881.6 million during the nine months ended September 30, 2010. The income taxes receivable at September 30, 2010 generally represents outstanding federal and state tax refunds from amended returns and net operating loss carrybacks. Of this amount, $52.8 million was received in October 2010.
In accordance with ASC 740, “Income Taxes,” the Company evaluates its deferred tax assets to determine if a valuation allowance is required. At September 30, 2010 and December 31, 2009, the Company had net deferred tax assets of $2.4 billion and $2.3 billion, respectively, which were offset by valuation allowances due to the uncertainty of realizing such deferred tax assets. The ultimate realization of these deferred tax assets is dependent upon the generation of taxable income during future periods. Changes in existing tax laws could also affect actual tax results and the valuation of deferred tax assets over time. The accounting for deferred taxes is based upon an estimate of future results. Differences between the anticipated and actual outcomes of these future tax consequences could have a material impact on the Company’s consolidated results of operations or financial position.
As a result of the Company’s merger with Centex, the Company’s ability to use certain of Centex’s pre-ownership net operating losses and built-in losses or deductions will be limited under Section 382 of the Internal Revenue Code. The Company’s Section 382 limitation is approximately $68.0 million per year for net operating losses, losses realized on built-in loss assets that are sold within five years of the ownership change, and certain deductions. The limitation may result in a significant portion of Centex’s pre-ownership change net operating loss carryforwards, built-in losses, and certain deductions not being available for use by the Company.
At September 30, 2010 and December 31, 2009, the Company had $276.4 million and $326.1 million, respectively, of gross unrecognized tax benefits and $54.5 million and $80.6 million, respectively, of accrued penalties and interest. The decreases in unrecognized tax benefits and accrued penalties and interest were primarily attributable to the aforementioned favorable resolution of certain federal and state income tax matters. The Company is currently under examination by the IRS and various state taxing jurisdictions and anticipates finalizing certain examinations within the next twelve months. The final outcome of those examinations is not yet determinable. It is reasonably possible, within the next twelve months, that the Company’s unrecognized tax benefits may decrease by $68.3 million, excluding interest and penalties, primarily due to potential settlements and expirations of certain statutes of limitations. The statute of limitations for the Company’s major tax jurisdictions remains open for examination for tax years 1998-2010.
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ASC 820, “Fair Value Measurements and Disclosures,” provides a framework for measuring fair value in generally accepted accounting principles and establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The fair value hierarchy can be summarized as follows:
The Company’s financial instruments measured at fair value on a recurring basis are summarized below ($000’s omitted):
Financial Instrument
See Note 1 of these Condensed Consolidated Financial Statements regarding the fair value of mortgage loans available-for-sale and derivative instruments and hedging activities.
In addition, certain of the Company’s assets are required to be recorded at fair value on a non-recurring basis when events and circumstances indicate that the carrying value may not be recoverable. The Company’s assets measured at fair value on a non-recurring basis are summarized below ($000’s omitted):
Loans held for investment
The fair values included in the table above represent only those assets whose carrying values were adjusted to fair value in the current quarter. The Company measured certain of its loans held for investment at fair value since the cost of the loans exceeded their fair value. Fair value of the loans was determined based on the fair value of the underlying collateral. For house and land inventory, see Note 5 of these Condensed Consolidated Financial Statements for a more detailed discussion of the valuation method used.
The carrying amounts of cash and equivalents approximate their fair values due to their short-term nature. The fair values of senior notes are based on quoted market prices, when available. If quoted market prices are not available, fair values are based on quoted market prices of similar issues. At September 30, 2010, the fair value of the senior notes outstanding approximated $4.2 billion compared with the carrying value of $4.3 billion. The carrying value of collateralized short-term debt approximates fair value.
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4.55% unsecured senior notes, issued by Centex Corp. due 2010 (b)
7.875% unsecured senior notes, issued by Centex Corp. due 2011 (b)
8.125% unsecured senior notes, issued by PulteGroup, Inc. due 2011, (a)
7.875% unsecured senior notes, issued by PulteGroup, Inc. due 2011 (c)
7.50% unsecured senior notes, issued by Centex Corp. due 2012 (b)
5.45% unsecured senior notes, issued by Centex Corp. due 2012 (b)
6.25% unsecured senior notes, issued by PulteGroup, Inc. due 2013 (c)
5.125% unsecured senior notes, issued by Centex Corp. due 2013 (b)
5.25% unsecured senior notes, issued by PulteGroup, Inc. due 2014 (c)
5.70% unsecured senior notes, issued by Centex Corp. due 2014 (b)
5.2% unsecured senior notes, issued by PulteGroup, Inc. due 2015 (c)
5.25% unsecured senior notes, issued by Centex Corp. due 2015 (b)
6.50% unsecured senior notes, issued by Centex Corp. due 2016 (b)
7.625% unsecured senior notes, issued by PulteGroup, Inc. due 2017 (a)
7.875% unsecured senior notes, issued by PulteGroup, Inc. due 2032 (c)
6.375% unsecured senior notes, issued by PulteGroup, Inc. due 2033 (c)
6.0% unsecured senior notes, issued by PulteGroup, Inc. due 2035 (c)
7.375% unsecured senior notes, issued by PulteGroup, Inc. due 2046 (d)
Total senior notes - carrying value
Estimated fair value
On October 21, 2010, the Company completed a tender offer of $500.0 million of its senior notes in several series due 2013 through 2015. As a result of the tender offer, a loss of approximately $27.8 million will be recorded in the fourth quarter of 2010.
Pulte Mortgage provides mortgage financing for many of the Company’s home sales and uses its own funds and borrowings made available pursuant to certain third party and intercompany borrowings. Pulte Mortgage uses these resources to finance its lending activities until the mortgage loans are sold to third party investors, generally within 30 days. As of September 30, 2010, Pulte Mortgage allowed its third party borrowing agreements to expire without replacement. Given the Company’s strong liquidity and the cost of third party financing relative to existing mortgage rates, Pulte Mortgage currently funds its operations using internal Company resources.
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Loan origination liabilities
The Company’s mortgage operations have established liabilities for anticipated losses associated with mortgage loans originated and sold to investors that may result from borrower fraud, borrower early payment defaults, or loans that have not been underwritten in accordance with the investor guidelines. In the normal course of business, the Company’s mortgage operations also provide limited indemnities for certain loans sold to the investors. If determined to be at fault, the Company either repurchases the loans from the investors or reimburses the investors’ losses. The Company establishes liabilities for such anticipated losses based upon, among other things, historical loss rates, trends in loan originations, and the geographic location of the underlying collateral. Effective with the Centex merger, the Company assumed loan repurchase liabilities totaling $52.6 million. Beginning in 2009, the Company experienced a significant increase in anticipated losses as a result of the high level of loan defaults and related losses in the mortgage industry and increasing aggressiveness by investors in presenting such claims to the Company. The vast majority of these losses relate to loans originated in 2006 and 2007 when lending standards were less stringent and borrower fraud is believed to have peaked. Given the volatility in the mortgage industry and the uncertainty regarding the ultimate resolution of these claims, it is reasonably possible that future losses may exceed the Company’s current estimates. Changes in these liabilities are as follows ($000’s omitted):
Liabilities, beginning of period
Provision for losses
Settlements
Liabilities, end of period
Community development and other special district obligations
A community development district or similar development authority (“CDD”) is a unit of local government created under various state statutes that utilizes the proceeds from the sale of bonds to finance the construction or acquisition of infrastructure assets of a development. A portion of the liability associated with the bonds, including principal and interest, is assigned to each parcel of land within the development. This debt is typically paid by subsequent special assessments levied by the CDD on the landowners. Generally, the Company is only responsible for paying the special assessments for the period in which it is the landowner of the applicable parcels. However, in certain limited instances the Company records a liability for future assessments that are fixed or determinable for a fixed or determinable period in accordance with ASC 970-470, “Real Estate Debt”. At September 30, 2010 and December 31, 2009, the Company had recorded $207.4 million and $224.3 million, respectively, in accrued liabilities for outstanding CDD obligations.
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Letters of credit and surety bonds
In the normal course of business, the Company posts letters of credit and surety bonds pursuant to certain performance related obligations, as security for certain land option agreements, and under various insurance programs. At September 30, 2010 and December 31, 2009 the Company had outstanding letters of credit and surety bonds totaling $1.8 billion and $2.0 billion, respectively.
In addition, the Company is subject to approximately $1.4 billion of surety bonds related to certain construction obligations of Centex’s previous commercial construction business, which was sold by Centex on March 30, 2007. The Company estimates that less than $125.0 million of work remains to be performed on these commercial construction projects. No event has occurred that has led the Company to believe that these bonds will be drawn upon. Additionally, the purchaser of the Centex commercial construction business has indemnified the Company against potential losses relating to such surety bond obligations. As additional security, the Company has purchased for its benefit a back-up indemnity provided by a financial institution with an investment grade credit rating. The obligation of such financial institution under the back-up indemnity is limited to $400 million and terminates in 2016, if not previously terminated by the Company.
Litigation
The Company is involved in various litigation incidental to its business operations. While the outcome of such litigation cannot be predicted with certainty, management does not believe that the resolution of such litigation will have a material adverse impact on the results of operations, financial position, or cash flows of the Company.
Self-insured risks
The availability of general liability insurance for the homebuilding industry and its subcontractors has become increasingly limited and more expensive in recent years. The Company retains a significant portion of its overall insurance losses. In certain instances, the Company may offer its subcontractors the opportunity to purchase insurance through one of the Company’s captive insurance subsidiaries or to participate in a project specific insurance program provided by the Company. The project specific insurance programs may be purchased from the captive insurance subsidiaries or through a third party insurance company. Any policy issued by the captive insurance subsidiaries represents self-insurance of these risks by the Company.
The Company reserves for costs associated with claims and their related lawsuits, which are covered by policies issued by the Company’s insurance subsidiaries or through its own self-insured retentions or deductibles. These reserves are based on an actuarial analysis of the Company’s historical claims. The actuarial analysis includes an estimate of claims incurred but not reported. These estimates make up a significant portion of the Company’s estimates and are subject to a high degree of uncertainty due to a variety of factors, including changes in claims reporting and resolution patterns, third party recoveries, insurance industry practices, the regulatory environment, and legal precedent. State regulations vary, but claims are reported and resolved over an extended period often exceeding ten years. As a result, actual costs could differ significantly from estimated costs.
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Self-insured risks (continued)
Adjustments to estimated reserves are recorded in the period in which the change in estimate occurs. During the three months ended September 30, 2010, the Company experienced a greater than anticipated frequency of newly reported claims and an increase in specific case reserves related to known claims for homes closed in prior periods. As a result of these unfavorable trends, the Company recorded additional expense to insurance reserves totaling $272.2 million ($0.72 per basic and diluted share) and $291.8 million ($0.77 per basic and diluted share) for the three and nine months ended September 30, 2010, respectively. The Company recorded these expenses in the Consolidated Statements of Operations within selling, general, and administrative expenses. Substantially all of these increases related to general liability reserves. The Company’s recorded reserves for all general liability insurance claims totaled $782.8 million and $513.0 million at September 30, 2010 and December 31, 2009, respectively. The recorded reserves include an actuarial assessment of incurred but not reported claims, which represent approximately 78% and 75% of the total general liability reserves at September 30, 2010 and December 31, 2009, respectively. Changes in the number and timing of reported claims and the estimates of specific claim values will significantly impact estimates of future reserves, which are reflected by the incurred but not reported reserve.
In certain instances, the Company has the ability to recover a portion of its costs under various insurance policies or from its subcontractors or other third parties. Estimates of such amounts are recorded when recovery is considered probable and are reflected in the Company’s actuarial analysis. The Company’s insurance policies are maintained with highly-rated underwriters for whom the Company believes counterparty default risk is not significant.
All of the Company’s senior notes are guaranteed jointly and severally on a senior basis by each of the Company’s wholly-owned Homebuilding subsidiaries and certain other wholly-owned subsidiaries (collectively, the Guarantors). Such guaranties 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.
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CONDENSED CONSOLIDATING BALANCE SHEET
September 30, 2010
ASSETS
Securities purchased under agreements to resell
Deferred income tax assets
Investments in subsidiaries and intercompany accounts, net
LIABILITIES AND SHAREHOLDERS’ EQUITY
Accounts payable, customer deposits, accrued and other liabilities
Total shareholders’ equity
34
December 31, 2009
35
CONSOLIDATING STATEMENT OF OPERATIONS
For the three months ended September 30, 2010
Revenues
Homebuilding Cost of Revenues
Intercompany interest
Equity in earnings (loss) of unconsolidated entities
Income (loss) before income taxes and equity in earnings (loss) of subsidiaries
Income (loss) before equity in earnings (loss) of subsidiaries
Equity in earnings (loss) of subsidiaries
36
For the nine months ended September 30, 2010
37
For the three months ended September 30, 2009
38
For the nine months ended September 30, 2009
39
CONSOLIDATING STATEMENT OF CASH FLOWS
Investment in subsidiaries
Dividends received from subsidiaries
Net borrowings under Financial Services credit arrangements
Repayment of other borrowings
Capital contributions from parent
Advances (to) from affiliates
Dividends paid
Net increase in cash and equivalents
40
Net repayments under Financial Services credit arrangements
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Overview
On August 18, 2009, we completed the acquisition of Centex through the merger of PulteGroup’s merger subsidiary with and into Centex pursuant to the Agreement and Plan of Merger dated as of April 7, 2009 among PulteGroup, Pi Nevada Building Company, and Centex. As a result of the merger, Centex became a wholly-owned subsidiary of PulteGroup. Accordingly, the results of Centex are included in our consolidated financial statements from the date of the merger.
Since early 2006, the U.S. housing market has been unfavorably impacted by a lack of consumer confidence, tightened mortgage standards, and large supplies of resale and new home inventories and related pricing pressures, among other factors. When combined with the significant foreclosure activity, a more challenging appraisal environment, higher than normal unemployment levels, and uncertainty in the U.S. economy in recent periods, these conditions have contributed to sharply weakened demand for new homes, slower sales, and pricing pressures to attract homebuyers. As a result, we have experienced a pre-tax loss in each quarter since the fourth quarter of 2006. Such losses resulted from a combination of reduced operational profitability and significant asset impairments. Since the beginning of 2006, we have incurred total land-related charges of $5.3 billion and goodwill impairments of $1.6 billion.
The U.S. housing market and broader economy remain in a period of uncertainty; however, we are beginning to see signs of stabilization in certain of our local markets, though at near historically low levels. This more stable environment resulted in a significant reduction in the level of land-related charges recorded during 2010 compared with recent years. We believe our strategic merger with Centex positions us well for a recovery in the homebuilding industry. However, significant short-term uncertainty remains. The expiration of the federal homebuyer tax credit, which was applicable to orders under contract by April 30 and closed by September 30, favorably impacted our revenues for the first half of 2010 but also contributed to industry-wide softness in new orders since May 2010. Other factors that may further worsen market conditions or delay a recovery in the homebuilding industry include:
Continued high levels of foreclosure activity;
High levels of unemployment, which are generally not expected to recede to historical levels during 2010 or 2011;
Potentially higher mortgage interest rates, which might result from a variety of macroeconomic factors, as the current level of historically low mortgage interest rates is not believed to be sustainable for the long-term;
Increased costs and standards related to FHA loans, which became a significant source of customer financing for the homebuilding industry in 2009 and continues to be so in 2010;
The overall impact of the federal government’s intervention in the U.S. economy, including the expiration of various economic stimulus programs; and
Potential impacts of reforms to the overall U.S. financial services and mortgage industries that may have an adverse impact on the ability of our customers to finance their home purchases or on our access to the capital markets, including the Dodd-Frank Wall Street Reform and Consumer Protection Act enacted into law on July 21, 2010 and the potential re-privatization of the government-sponsored enterprises commonly known as Fannie Mae and Freddie Mac.
Accordingly, we continue to operate our business with the expectation that difficult market conditions will continue to impact us for at least the near term. While we are purchasing select land positions where it makes strategic and economic sense to do so, our targeted profile for such investments consists of developed lots, frequently under rolling lot option contracts, that are cash flow positive early in the project cycle and accretive to earnings. We also continue to evaluate each existing land parcel to determine whether the strategy and economics support holding the parcel or disposing of it. We have closely evaluated and made significant reductions in employee headcount and overhead expenses since the beginning of the industry downturn and in conjunction with the Centex merger. Due to the persistence of these difficult market conditions, improving the efficiency of our overhead costs will continue to be a significant area of focus, including additional consolidation and streamlining of certain of our field teams and corporate functions in the fourth quarter of 2010. We are also adjusting the content in our homes to provide our customers more affordable alternatives, including building homes with smaller floor plans in certain of our communities. We are maintaining our focus on our lean operating goals, a long-term initiative designed to extract unnecessary waste out of the home construction process. The targeted benefits include better scheduling, direct-order of materials, eliminating waste at the construction site, and reducing the amount of time it takes to build our homes.
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Overview (continued)
As a result of the Centex merger, we are achieving significant savings in corporate and divisional overhead costs and interest costs for the combined entity. We are also achieving synergies in our purchasing leverage and integrating the combined organization’s operational best practices. We anticipate that the Centex merger will contribute to growth through expanded geographic and customer segment diversity and the ability to leverage additional brands. We believe that the combination of our operational improvement activities with the benefits of the Centex merger will help strengthen our market position and allow us to take advantage of opportunities that may develop in the future.
Our outlook is tempered by caution for the remainder of 2010 and into 2011. If the negative trends in economic conditions or financial market volatility experienced in recent years return either nationally or to any of our local markets, it could adversely affect our business and results of operations in future periods, including a further reduction in the demand for housing as well as difficulties in accessing financing on acceptable terms. Given these conditions and the continued weakness in new home sales, visibility as to future earnings performance is limited. Our evaluation for land-related charges recorded to date assumed our best estimates of cash flows for the communities tested. If conditions in the homebuilding industry or our local markets worsen in the future, or if our strategy related to certain communities changes, we may be required to evaluate our assets, including additional projects, for further impairments or write-downs, which could result in future charges that might be significant.
The following is a summary of our operating results by line of business for the three and nine months ended September 30, 2010 and 2009 ($000’s omitted, except per share data):
Other non-operating
Income (loss) before income taxes
Per share data - assuming dilution:
The Homebuilding losses experienced in the three and nine months ended September 30, 2010 were primarily the result of goodwill impairments totaling $654.9 million and $656.3 million, respectively, and the adverse impact of certain insurance claims, which totaled $272.2 million and $291.8 million, respectively. For additional information regarding the goodwill impairments and insurance charges, see Notes 3 and 12, respectively, to the Condensed Consolidated Financial Statements. Land-related charges totaled $59.2 million and $163.8 million for the three months ended September 30, 2010 and 2009, respectively, and $94.5 million and $693.3 million for the nine months ended September 30, 2010 and 2009, respectively. The loss for the three and nine months ended September 30, 2009 also included transaction and integration costs directly related to the Centex merger totaling $76.7 million and $82.5 million, respectively. Such costs consisted primarily of severance benefits, lease exit and related asset impairment costs, investment banking fees, and other professional fees.
The Financial Services income in 2010 is primarily attributable to higher loan origination volume for the nine months ended September 30, 2010 combined with lower charges related to loan repurchase liabilities. The losses in 2009 reflect a combination of charges related to loan repurchase liabilities and reduced loan origination volume resulting from lower Homebuilding revenues. The loss for the three and nine months ended September 30, 2009 also includes certain transaction and integration costs directly related to the Centex merger totaling $4.5 million for both periods. Such costs consisted primarily of severance benefits and lease exit and related asset impairment costs.
Other non-operating loss before income taxes for the three and nine months ended September 30, 2009 includes significant losses related to the repurchase of debt and certain transaction and integrations costs directly related to the Centex merger. Excluding these items, our Other non-operating loss increased for the three and nine months ended September 30, 2010 compared with the prior year periods due primarily to increased compensation costs.
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Homebuilding Operations – Summary
The following table presents a summary of our Homebuilding operating results for the three and nine months ended September 30, 2010 and 2009 ($000’s omitted):
Total Homebuilding revenues
Home cost of revenues (a)
Land cost of revenues (b)
Selling, general and administrative expenses (c)
Equity in earnings (loss) of unconsolidated entities (d)
Other income (expense), net (e)
Active communities at September 30
Unit settlements (f)
Average selling price
Net new orders (h):
Units (f)
Dollars (g)
Backlog at September 30 (h):
Units
Dollars
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Homebuilding Operations – Summary (continued)
As indicated above, the Centex merger had a significant impact on the operating results for the three and nine months ended September 30, 2010. Excluding the impact of the Centex merger, our revenues, unit settlements, and net new orders would have experienced significant decreases from the prior year periods. Additionally, our reported home sale revenues, unit settlements, and net new orders for the nine months ended September 30, 2010 as reflected in the above tables represent decreases of 16%, 19%, and 30%, respectively, from the combined reported operating results of the two companies from the prior year period. However, these lower volumes were offset by the lower land-related charges, improved gross margins and operating leverage, and removal of the substantial majority of duplicative overhead costs from the combined companies. Excluding the impact of the goodwill impairments and casualty insurance losses recorded in the three months ended September 30, 2010, our income (loss) before income taxes for both the three and nine months ended September 30, 2010 are significantly improved from the losses reported by either company or the combined companies in the prior year periods. This illustrates the impact of the various actions we have taken to restructure our combined homebuilding operations into a more efficient organization.
Home sale revenues for the three months ended September 30, 2010, which include approximately $420.2 million related to Centex, were lower than those for the prior year period by 3%. Home sale revenues for the nine months ended September 30, 2010, which include approximately $1.5 billion related to Centex, were higher than those for the prior year period by 44%. The decrease in home sale revenues for the three months ended September 30, 2010 compared with the prior year period was attributable to a decrease in unit settlements of 7%, offset by an increase in average sales price of 5%. The increase in home sales revenues for the nine months ended September 30, 2010 compared with the prior period was attributable to an increase in unit settlements of 44% with little change in average sales price. The year to date increase in unit settlements was primarily attributable to the Centex merger. Average selling prices increased in the Midwest Area, but decreased slightly in each of our other Homebuilding segments during the nine months ended September 30, 2010 compared with the prior year period. Changes in average selling price reflect a combination of factors but were primarily attributable to shifts in the product and geographic mix of homes closed during the periods, including an increased concentration in the first-time buyer segment resulting from the Centex merger along with adjusting the product offering in certain communities to better align with current market conditions.
Homebuilding gross profit margins from home sales improved to 7.0% for the three months ended September 30, 2010 compared with negative 2.5% for the same period in the prior year. For the nine months ended September 30, 2010, Homebuilding gross profit margins were 10.9% compared with negative 19.0% for the same period in 2009. During the three and nine months ended September 30, 2010, we recorded land and community valuation adjustments of $57.5 million and $87.5 million, respectively, compared with $132.6 million and $600.4 million during the respective prior year periods. Excluding these land and community valuation adjustments and amortization of capitalized interest, gross profit margins were significantly higher during the three and nine months ended September 30, 2010 compared with the prior year periods, though down slightly from the second quarter of 2010 due to lower sales volumes. This improvement continues the margin expansion we have seen in recent quarters and reflects a combination of factors, including shifts in the product and geographic mix of homes closed during the quarter, better alignment of our product offering with current market conditions, and our various initiatives to reduce the construction cost of our homes.
We continue to evaluate our existing land positions to ensure the most effective use of capital. Land sale revenues and their related gains or losses may vary significantly between periods, depending on the timing of land sales. Land sales had positive margin contributions of $1.1 million and $9.2 million during the three and nine months ended September 30, 2010, respectively, compared with negative margin contributions of $9.5 million and $17.0 million during the three and nine months ended September 30, 2009, respectively. These margin contributions included net realizable value adjustments related to land held for sale totaling $0.6 million and $1.0 million for the three and nine months ended September 30, 2010, respectively, compared with $8.3 million and $16.2 million in the respective prior year periods.
45
Selling, general, and administrative expense as a percentage of home sale revenues was 40.7% for the three months ended September 30, 2010 compared with 19.8% for the same period in the prior year. For the nine months ended September 30, 2010, selling general and administrative expenses as a percentage of home sale revenues was 21.9% compared with 19.5% in the prior year period. Results for the three and nine months ended September 30, 2010 include the adverse impact of certain insurance claims totaling $272.2 million and $291.8 million, respectively. Excluding such charges, our selling, general, and administrative expense as a percentage of home sale revenues decreased significantly from the prior year periods. While the gross dollar amount of our overall selling, general and administrative costs increased as a result of the Centex merger and our higher volumes, our internal initiatives focused on controlling costs and matching our overall cost structure with the current business environment have resulted in significant improvements in our overhead leverage. Selling, general, and administrative costs also included severance costs of $7.1 million and $11.1 million for the three and nine months ended September 30, 2010. The three and nine months ended September 30, 2009 included transaction and integration costs related to the Centex merger, including severance, totaling $50.9 million and $56.6 million. The three months ended September 30, 2009 also included certain duplicative corporate and divisional overhead costs during the transition period following the Centex merger. Overall, we have achieved significant reductions in overhead costs since the Centex merger. However, our overhead leverage remains high relative to our sales volumes, so achieving a more efficient overhead structure remains an area of focus, including additional consolidation and streamlining of certain of our field teams and corporate functions in the fourth quarter of 2010.
Equity in earnings (loss) of unconsolidated entities was $(3.6) million and $1.8 million for the three and nine months ended September 30, 2010, respectively, compared with $(4.2) million) and $(57.2) million for the three and nine months ended September 30, 2009, respectively. The primary cause for this change in results is the lower levels of impairments related to these entities. The majority of our unconsolidated entities represent land development joint ventures, so the timing of income and losses can vary significantly between periods depending on the timing of transactions and circumstances specific to each entity.
Other income (expense), net includes the write-off (recovery) of deposits and pre-acquisition costs resulting from decisions not to pursue certain land acquisitions. These write-offs vary in amount from period to period as we continue to evaluate potential land acquisitions for the most effective use of capital. Other income (expense), net also includes goodwill impairments totaling $654.9 million and $656.3 million for the three and nine months ended September 30, 2010, respectively. Additionally, other income (expense), net includes certain lease exit costs and asset impairments related to overhead reduction efforts. Other income (expense), net for the nine months ended September 30, 2010 and 2009 also includes $10.2 million and $8.9 million, respectively, related to the net favorable resolution of certain contingencies. The impact of such items for the three months ended September 30, 2010 and 2009 was not significant.
For the three months ended September 30, 2010, net new order units decreased 12% compared with the same period in 2009. The decrease in net new orders was due primarily to the more challenging market conditions following the expiration of the federal homebuyer tax credit. For the nine months ended September 30, 2010, net new order units increased 16% compared with the same period in 2009. The increase in net new order units was primarily attributable to the positive impact of the federal homebuyer tax credit in the first half of 2010 and the Centex merger partially offset by a lower average sales pace per community and the revised criteria for recognizing new orders as discussed in the table above. At September 30, 2010, we had 796 active communities, a decrease of 17% from September 30, 2009 as we closed out of a number of smaller communities during 2010. Excluding Centex, net new order units decreased significantly for the three and nine months ended September 30, 2010 primarily due to the uncertainty in the overall U.S. housing industry combined with the expiration of the federal homebuyer tax credit. Cancellation rates for the third quarter of 2010 were 19% compared with 23% for the same period in 2009. The lower cancellation rate is partially due to the revised criteria for recognizing new orders. Our backlog levels are heavily dependent upon our net new order trends and totaled 5,345 units at September 30, 2010, a decrease of 36% from September 30, 2009.
We had 7,692 and 6,653 homes in production at September 30, 2010 and December 31, 2009, respectively, excluding 1,502 and 1,657 model homes, respectively. Included in our total homes in production were 3,616 and 2,793 homes that were unsold to customers at September 30, 2010 and December 31, 2009, respectively, of which 1,542 and 1,309 homes, respectively, were completed. The increased unsold and total homes in production at September 30, 2010 compared with December 31, 2009 is primarily the result of seasonality in our sales and production cycles in our local markets.
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At September 30, 2010 and December 31, 2009, our Homebuilding operations controlled 149,253 and 154,694 lots, respectively. Of these controlled lots, 133,380 and 138,273 lots were owned and 10,364 and 14,208 lots were under option agreements approved for purchase at September 30, 2010 and December 31, 2009, respectively. In addition, there were 5,509 lots and 2,213 lots under option agreements pending approval at September 30, 2010 and December 31, 2009, respectively. While we are purchasing select land positions where it makes strategic and economic sense to do so, the reduction in lots resulting from unit settlements, land disposition activity, and withdrawals from land option contracts exceeded the number of lots added by new transactions during the nine months ended September 30, 2010.
The total purchase price related to approved land under option for use by our Homebuilding operations at future dates totaled $739.2 million at September 30, 2010. These land option agreements, which may be cancelled at our discretion and may extend over several years, are secured by deposits and pre-acquisition costs totaling $97.7 million at September 30, 2010, of which $4.1 million is refundable. This balance excludes contingent payment obligations which may or may not become actual obligations to us.
Homebuilding Segment Operations
Our homebuilding operations represent our core business. Homebuilding offers a broad product line to meet the needs of first-time, first and second move-up, and active adult homebuyers. We have determined that our operating segments are our Areas. In connection with the Centex merger, we realigned the organizational structure for certain markets. The operating data by segment provided below have been reclassified to conform to the current presentation. We conduct our operations in 68 markets, located throughout 29 states and the District of Columbia and have presented our reportable Homebuilding segments as follows:
47
Homebuilding Segment Operations (continued)
The following table presents selected financial information for our reportable Homebuilding segments:
Home sale revenue (settlements):
Unit settlements:
Net new orders - units:
Unit backlog:
48
Controlled lots:
Northeast:
For the third quarter of 2010, Northeast home sale revenues decreased 21% compared with the prior year period due to a 20% decrease in unit settlements combined with a 2% decrease in the average selling price. Excluding Centex, home sale revenues and settlements decreased significantly, while average selling price increased slightly compared with the prior year period. The decreased loss before income taxes was primarily attributable to increased gross margins (both including and excluding land-related charges), improved overhead leverage from the prior year period, and a decrease in land-related charges to $3.7 million in the third quarter of 2010 compared with land-related charges of $63.3 million in the prior year period. Net new order units decreased 27% from the prior year period. Excluding Centex, net new order units for the quarter decreased significantly compared with the prior year period. The cancellation rate was 20% and 16% in the third quarters of 2010 and 2009, respectively.
For the nine months ended September 30, 2010, Northeast home sale revenues increased 58% compared with the prior year due to a 63% increase in unit settlements partially offset by a 3% decrease in the average selling price. Excluding Centex, sales revenues, settlements, and average selling price increased slightly compared with the prior year period. The income before income taxes was attributable to these higher revenues combined with lower land-related charges of $4.1 million in 2010 compared with $142.9 million in 2009 and impairments of $31.1 million in 2009 related to unconsolidated joint ventures. Gross margins including and excluding land-related charges also increased significantly from the prior year period. Net new order units remained constant with the prior year. Excluding Centex, net signups for the nine months ended September 30, 2010 moderately decreased from the prior year period.
Southeast:
For the third quarter of 2010, Southeast home sale revenues increased 15% compared with the prior year period due to an 11% increase in unit settlements combined with a 3% increase in the average selling price. The majority of the increased revenues is attributable to the Centex merger. Excluding Centex, home sale revenues and average selling price increased slightly and settlements decreased slightly compared with the prior year period. The income before income taxes was primarily attributable to these higher revenues, increased gross margins (both including and excluding land-related charges), and improved overhead leverage from the prior year period along with a decrease in land-related charges to $2.1 million in the third quarter of 2010 from $4.9 million in the prior year period. Net new order units decreased 10% from the prior year period. Excluding Centex, net new order units for the quarter decreased moderately compared with the prior year period. The cancellation rate was 14% and 19% in the third quarters of 2010 and 2009, respectively.
For the nine months ended September 30, 2010, Southeast home sale revenues increased 83% compared with the prior year due an 85% increase in the number of unit settlements, offset slightly by a 2% decrease in the average selling price. Excluding Centex, sales revenues and settlements increased moderately, while average selling price increased slightly compared with the prior year period. The income before income taxes was attributable to these higher revenues combined with lower land-related charges of $2.4 million in 2010 compared with $30.1 million in 2009. Gross margins both including and excluding land-related charges also increased from the prior year period. Net new order units increased 31% compared with the prior year primarily due to the Centex merger. Excluding Centex, net signups for the nine months ended September 30, 2010 decreased moderately from the prior year period.
49
Gulf Coast:
For the third quarter of 2010, Gulf Coast home sale revenues increased 12% compared with the prior year period due to a 4% increase in unit settlements and a 7% increase in the average selling price. The majority of the increased revenues are attributable to the Centex merger. Excluding Centex, home sale revenues and average sales price increased compared with the prior year period, while settlements slightly decreased compared with the prior year period. The decrease in loss before income taxes in the third quarter of 2010 was attributable to higher gross margins (excluding land-related charges), higher revenues, improved overhead leverage, and lower land-related charges. Land-related charges decreased to $21.2 million in the third quarter of 2010 compared with $28.4 million in the prior year period. Net new order units increased by 7% due to the Centex merger. Excluding Centex, net new order units for the quarter decreased moderately compared with the prior year period. The cancellation rate was 20% and 25% in the third quarters of 2010 and 2009, respectively.
For the nine months ended September 30, 2010, Gulf Coast home sale revenues increased 60% compared with the prior year due to a 65% increase in unit settlements, offset partially by a 3% decrease in the average selling price. Excluding Centex, sales revenues and settlements decreased slightly compared with the prior year period, while average selling price increased slightly. The significant decrease in loss before income taxes was attributable to higher revenues and lower land-related charges of $30.0 million in 2010 compared with $153.4 million in 2009. Gross margins including and excluding land-related charges also increased from the prior year period. Net new order units increased 47% compared with the prior year primarily due to the Centex merger. Excluding Centex, net signups for the nine months ended September 30, 2010 decreased moderately from the prior year period.
Midwest:
Midwest home sale revenues increased 6% during the quarter compared with the prior year period due to a 6% decrease in unit settlements offset by a 13% increase in the average selling price. The majority of the increased revenues are attributable to the Centex merger. Excluding Centex, home sale revenues and settlements decreased and average selling price increased moderately compared with the prior year period. The income before income taxes increased in the third quarter of 2010 compared with the third quarter of 2009 primarily due to higher revenues combined with higher gross margins (including and excluding land-related charges), improved overhead leverage, and lower land-related charges. Land-related charges decreased to $2.0 million from $0.8 million in the prior year period. Net new order units decreased by 14% compared with the prior year period. Excluding Centex, net new order units for the quarter decreased moderately compared with the prior year period. The cancellation rate in the third quarter of 2010 was 14% compared with 17% in the same period in 2009.
For the nine months ended September 30, 2010, Midwest home sale revenues increased 45% compared with the prior year due to a 39% increase in unit settlements and a 4% increase in the average selling price. Excluding Centex, sales revenues and settlements decreased slightly, while the average selling price increased compared with the prior year period. The income before income taxes was attributable to these higher revenues combined with higher gross margins (including and excluding land-related charges), improved overhead leverage, and lower land-related charges. Land-related charges decreased to $6.7 million in 2010 compared with $35.8 million in 2009. Net new order units increased 22% compared with the prior year primarily due to the Centex merger. Excluding Centex, net signups for the nine months ended September 30, 2010 decreased moderately from the prior year period.
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Southwest:
The Centex merger contributed little to the Southwest’s operations due to Centex’s limited presence in these markets. For the three months ended September 30, 2010, Southwest home sale revenues decreased 31% compared with the prior year period due to a 36% decrease in unit settlements offset partially by a 7% increase in average selling prices. The decreased loss before income taxes in the third quarter of 2010 resulted primarily from lower land-related charges totaling $19.3 million, compared with charges of $26.9 million in the prior year period, along with higher gross margins (including and excluding land-related charges) and improved overhead leverage during 2010. Net new order units decreased 33% compared with the prior year period due to a decrease in the number of active communities combined with the ongoing difficult market conditions in Phoenix and Las Vegas. The cancellation rate was 19% and 30% in the third quarters of 2010 and 2009, respectively.
For the nine months ended September 30, 2010, Southwest home sale revenues decreased 22% compared with the prior year period due to a 22% decrease in unit settlements and consistent average selling prices. The decreased loss before income taxes from the prior year period is attributable to significantly higher gross margins (including and excluding land-related charges) and lower land-related charges. Land related charges decreased to $19.3 million in 2010 compared with $138 million in 2009 and impairments of $19.3 million in 2009 related to unconsolidated joint ventures. Net new order units decreased 34% compared with the prior year period primarily due to a small decrease in the number of active communities combined with the ongoing difficult market conditions in Phoenix and Las Vegas.
West:
For the third quarter of 2010, West home sale revenues decreased 13% compared with the prior year period due to a 13% decrease in unit settlements and steady average selling prices. Excluding Centex, home sale revenues and settlements decreased moderately, while average selling price increased slightly compared with the prior year period. The income before income taxes resulted from increased gross margins (including and excluding land-related charges), and improved overhead leverage offset by land-related charges totaling $3.3 million. Land-related charges totaled $18.6 million for the three months ended September 30, 2009 and impairments in an unconsolidated joint venture totaled $5.8 million. Net new order units decreased by 14% in the third quarter of 2010 compared with the same period in the prior year. Excluding Centex, net new order units for the quarter were moderately lower than the prior year period. The cancellation rate was 27% and 23% in the third quarters of 2010 and 2009, respectively.
For the nine months ended September 30, 2010, West home sale revenues increased 36% compared with the prior year due to a 40% increase in unit settlements, offset slightly by a 3% decrease in average selling price. Excluding Centex, sales revenues and settlements decreased moderately, while average selling price decreased slightly compared with the prior year period. The income before income taxes was attributable to these higher revenues, higher gross margins (both including and excluding land-related charges), and lower land-related charges of $16.2 million in 2010 compared with $77.5 million in 2009. The income before taxes in 2010 was partially offset by impairments of $1.9 million related to unconsolidated joint ventures. Net new order units increased 24% compared with the prior year primarily due to the Centex merger. Excluding Centex, net signups for the nine months ended September 30, 2010 decreased moderately from the prior year period.
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Financial Services Operations
We conduct our financial services business, which includes mortgage and title operations, through Pulte Mortgage and other subsidiaries. We originate mortgage loans using our own funds or borrowings made available through various credit arrangements, and then sell such mortgage loans monthly to outside investors. Also, we sell our servicing rights on a flow basis through fixed price servicing sales contracts. The following table presents selected financial information for our Financial Services segment ($000’s omitted):
Mortgage operations revenues
Title services revenues
Total Financial Services revenues
Expenses
Equity in earnings of unconsolidated entities
Total originations:
Loans
Principal
For the three and nine months ended September 30, 2010, Financial Services earned income before income taxes of $3.5 million and $0.4 million, respectively, compared with a loss before income taxes of $8.6 million and $18.7 million during the respective prior year periods. The improved operating results in 2010 is primarily attributable to lower expenses related to loan repurchase liabilities, higher year-to-date origination volumes, and improved operating efficiencies.
Our Homebuilding customers continue to account for substantially all loan production, representing 97% and 99% of loan originations for the three and nine months ended September 30, 2010 compared with 99% and 97% during the respective prior year periods. Total Financial Services revenues for the three and nine months ended September 30, 2010, decreased 21% and increased 27%, respectively, compared with the respective prior year periods. These changes were primarily attributable to changes in home settlement volumes in 2010 compared with the same periods in 2009.
Agency production for funded originations was 99% of total loan originations for the nine months ended September 30, 2010 and 2009. Within the funded agency originations, FHA loans represented 40% during the nine months ended September 30, 2010, compared with 37% in the prior year period. Our capture rate was 77% for the nine months ended September 30, 2010 compared with 89% in the respective prior year period. Our capture rate represents loan originations from our Homebuilding operations as a percentage of total loan opportunities from our Homebuilding operations, excluding cash settlements. At September 30, 2010, our loan application backlog was $825.8 million compared with $1.2 billion at September 30, 2009.
Substantially all loan production in 2010 and 2009 consisted of fixed rate loans, the majority of which are prime, conforming loans. We define prime loans as full documentation first mortgages with FICO scores of 621 or higher, Alt-A loans as non-full documentation first mortgages with FICO scores of 621 or higher, and sub-prime loans as first mortgages with FICO scores of 620 or lower. The shift toward agency fixed-rate loans has contributed to profitability as such loans generally result in higher profitability due to higher servicing values, less competition, and structured guidelines that allow for expense efficiencies when processing the loan.
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Financial Services Operations (continued)
Since we sell the majority of our loans monthly and retain only limited risk related to the loans we originate, our overall loan losses have historically not been significant. In recent quarters, however, we have experienced higher than historical losses on our loans held for investment, repurchased or re-insured loans, and foreclosed properties. The largest source of these losses has been a significant increase in anticipated losses for loans previously originated and sold to investors. Such losses may result from borrower fraud, borrower early payment defaults, or loans that were not underwritten in accordance with investor guidelines. In the normal course of business, our mortgage operations also provide limited indemnities for certain loans sold to investors. If determined to be at fault, we either repurchase the loans from the investors or reimburse the investors’ losses. We establish liabilities for such anticipated losses based upon, among other things, historical loss rates, trends in loan originations, and the geographic location of the underlying collateral. Beginning in 2009, we have experienced a significant increase in anticipated losses as a result of the high level of loan defaults and related losses in the mortgage industry and increasing aggressiveness by investors in presenting such claims to us. Additionally, Centex’s mortgage operations were historically broader than those of Pulte Mortgage, so our exposure to losses related to loans previously originated has increased significantly. While not increasing our exposure to Centex’s contingent loan origination liabilities, the Company entered into an agreement in conjunction with the wind down of Centex’s mortgage operations, which originated its last loan in December 2009, that provides a guaranty for one major investor in loans originated by Centex’s mortgage operations. This guaranty provides that the Company will honor the potential repurchase obligations of Centex’s mortgage operations related to breaches of representations and warranties in the origination of a certain pool of loans. Other than with respect to this pool of loans, our contractual repurchase obligations are limited to the Company’s non-guarantor subsidiaries (see Note 13 for discussion of non-guarantor subsidiaries).
The vast majority of losses related to our overall exposure for loans previously originated and sold to investors relate to loans originated in 2006 and 2007 when lending standards were less stringent and borrower fraud is believed to have peaked. Given the volatility in the mortgage industry and the uncertainty regarding the ultimate resolution of these claims, it is reasonably possible that future losses may exceed our current estimates. Changes in these liabilities are as follows ($000’s omitted):
We are exposed to market risks from commitments to lend, movements in interest rates, and cancelled or modified commitments to lend. A commitment to lend at a specific interest rate (an interest rate lock commitment) is a derivative financial instrument (interest rate is locked to the borrower). In order to reduce these risks, we use other derivative financial instruments to economically hedge the interest rate lock commitment. These financial instruments can include cash forward placement contracts on mortgage-backed securities, whole loan investor commitments, options on treasury futures contracts, and options on cash forward placement contracts on mortgage-backed securities. We enter into one of the aforementioned derivative financial instruments upon accepting interest rate lock commitments. The changes in the fair value of the interest rate lock commitment and the other derivative financial instruments are included in Financial Services revenues. We do not use any derivative financial instruments for trading purposes.
Other Non-Operating
Other non-operating expenses consist of income and expenses related to corporate services provided to our subsidiaries. These expenses are incurred for financing, developing and implementing strategic initiatives centered on new business development and operating efficiencies, and providing the necessary administrative support associated with being a publicly-traded entity listed on the New York Stock Exchange. Accordingly, these results will vary from period to period as these strategic initiatives and costs evolve.
The following table presents other non-operating expenses for the three and nine months ended September 30, 2010 and 2009 ($000’s omitted):
Net interest income
Other income (expenses), net
The increase in net interest income for the three months ended September 30, 2010 compared with the prior year period resulted from higher invested cash balances and a corporate note receivable partially offset by lower interest rates. The lower interest rates in 2010 resulted in a decline in net interest income for the nine months ended September 30, 2010. The decrease in selling, general and administrative expenses for the three months ended September 30, 2010 compared with the prior year period is due primarily to the prior year period containing certain transaction and integration costs resulting from the Centex merger totaling $5.5 million. Excluding such costs, the increase in selling, general, and administrative expenses for the three and nine months ended September 30, 2010 compared with the prior year periods is attributable primarily to increased compensation costs. Other income (expenses), net for the three and nine months ended September 30, 2009 losses related to the repurchases of senior notes.
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Other Non-Operating (continued)
We capitalize interest cost into inventory during the active development and construction of our communities. Each layer of capitalized interest is amortized over a period that approximates the average life of communities under development. Interest expense is allocated over the period based on the cyclical timing of closings. Interest expensed to homebuilding cost of revenues for the three and nine months ended September 30, 2010 included $7.6 million and $13.8 million, respectively, of capitalized interest related to land and community valuation adjustments compared with $15.1 million and $57.0 million for the three and nine months ended September 30, 2009, respectively. The level of our active inventory was lower than our debt level at September 30, 2010. Therefore, $0.9 million of Homebuilding interest costs were expensed directly to interest expense.
Income Taxes
Our income tax assets and liabilities and related effective tax rate are affected by a number of factors, the most significant of which are the valuation allowance recorded against our deferred tax assets and changes in our unrecognized tax benefits. Due to the effects of our valuation allowance and changes in our unrecognized tax benefits, our effective tax rates for the three and nine months ended September 30, 2010 and 2009 are not meaningful as our income tax expense (benefit) is not directly correlated to the amount of our pretax income (loss). The income tax benefit for the nine months ended September 30, 2010 was primarily due to the favorable resolution of certain federal and state income tax matters.
Liquidity and Capital Resources
We finance our land acquisition, development, and construction activities by using internally-generated funds and existing credit arrangements. We routinely monitor current and expected operational requirements and financial market conditions to evaluate the use of available financing sources, including securities offerings. Based on our current financial condition and credit relationships, we believe that our operations and borrowing resources are sufficient to provide for our current and foreseeable capital requirements. However, we continue to evaluate the impact of market conditions on our liquidity and may determine that modifications are appropriate if market conditions deteriorate or if the current difficult market conditions extend beyond our expectations.
At September 30, 2010, we had cash and equivalents of $2.7 billion and no borrowings outstanding under our unsecured revolving credit facility (the “Credit Facility”). We also had $4.3 billion of senior notes outstanding. Other financing included limited recourse land-collateralized financing totaling $0.6 million. Sources of our working capital include our cash and equivalents, our Credit Facility, and our unsecured letter of credit facility (the “LOC Agreement”). An additional source of liquidity during the nine months ended September 30, 2010 was the receipt of federal tax refunds aggregating $881.6 million, plus an additional $52.8 million received in October 2010. Such refunds resulted primarily from the carryback of taxable losses provided for under the Worker, Homeownership, and Business Assistance Act of 2009.
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Liquidity and Capital Resources (continued)
We follow a diversified investment approach for our cash and equivalents by maintaining such funds with a diversified portfolio of banks within our group of relationship banks in high quality, highly liquid, short-term investments, generally money market funds and federal government or agency securities. We monitor our investments with each bank and do not believe our cash and equivalents are exposed to any material risk of loss. However, there can be no assurances that losses of principal balance on our cash and equivalents will not occur.
Our ratio of debt-to-total capitalization, excluding our land-collateralized debt, was 65.1% at September 30, 2010, and 42.0% net of cash and equivalents.
Under the terms of the Credit Facility, we have the capacity to issue letters of credit totaling up to $750.0 million. Borrowing availability is reduced by the amount of letters of credit outstanding. The Credit Facility includes a borrowing base limitation when we do not have an investment grade senior unsecured debt rating from at least two of Fitch Ratings, Moody’s Investor Service, and Standard and Poor’s Corporation (the “Rating Agencies”). We currently do not have investment grade ratings from any of the Rating Agencies and are therefore subject to the borrowing base limitation. Given the uncertainty of current market conditions, we anticipate operating under the borrowing base limitation for the foreseeable future. Under the borrowing base limitation, the sum of our senior debt and the amount drawn on the Credit Facility may not exceed an amount based on certain percentages of various categories of our unencumbered inventory and other assets. At September 30, 2010, we had no borrowings outstanding and full availability of the remaining $447.0 million under the Credit Facility after consideration of $303.0 million of outstanding letters of credit. As a result, the borrowing base limitation did not restrict our borrowing availability at September 30, 2010.
We are required to maintain certain liquidity reserve accounts in the event we fail to satisfy an interest coverage test. Specifically, if the interest coverage ratio (as defined in the Credit Facility) is less than 2.0 to 1.0, we are required to maintain cash and equivalents in designated accounts with certain banks. While our access to and utilization of cash and equivalents maintained in liquidity reserve accounts is not restricted, failure to maintain sufficient balances within the liquidity reserve accounts restricts our ability to utilize the Credit Facility. We maintained the required cash and equivalents of $519.9 million within the liquidity reserve accounts at September 30, 2010, calculated under the Credit Facility as two times the amount by which the interest incurred over the last four quarters exceeds interest income over the last four quarters, excluding Financial Services. Additionally, failure to satisfy the interest coverage test can also result in an increase to LIBOR margin and letter of credit pricing. Our interest coverage ratio for the twelve months ended September 30, 2010 was negative 0.7. For the period ending December 31, 2010, we will be required to maintain cash and equivalents of $532.9 million within the liquidity reserve accounts, calculated as of September 30, 2010.
The Credit Facility contains certain financial covenants. We are required to not exceed a debt to tangible capital ratio as well as to meet a tangible net worth covenant each quarter. At September 30, 2010, our debt to tangible capital ratio (as defined in the Credit Facility) was 55.0% (compared with the requirement not to exceed 60.0%) while our tangible net worth (as defined in the Credit Facility) cushion was $631.8 million. Violations of any of the covenants in the Credit Facility, if not waived by the lenders or cured, could result in an optional maturity date acceleration by the lenders, which could require replacement or cash collateralization of any letters of credit outstanding under the Credit Facility. In the event these violations were not waived by the lenders or cured, the violations could also result in a default under our $4.3 billion of senior notes.
As of September 30, 2010, the Company was in compliance with all of the covenants under the Credit Facility. However, in the event market conditions deteriorate in the future or the Company incurs additional land-related charges, the Company’s compliance with the required covenant levels may be adversely impacted. Additionally, the Company’s ability to utilize the full capacity of the Credit Facility may be limited under the terms of the borrowing base.
In June 2009, the Company entered into the LOC Agreement, a five-year, unsecured letter of credit facility that permits the issuance of up to $200.0 million of letters of credit by the Company. The LOC Agreement supplements the Company’s existing letter of credit capacity included in our Credit Facility. At September 30, 2010, $148.1 million of letters of credit were outstanding under the LOC Agreement.
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Pulte Mortgage provides mortgage financing for many of the Company’s home sales and uses its own funds and borrowings made available pursuant to certain third party and intercompany borrowings. Pulte Mortgage uses these resources to finance its lending activities until the mortgage loans are sold to third party investors, generally within 30 days. As of September 30, 2010, Pulte Mortgage allowed its third party borrowing agreements to expire without replacement. Given the Company’s strong liquidity and the cost of third party financing relative to existing mortgage rates, Pulte Mortgage’s operations are currently funded by the Company. At September 30, 2010, we elected to fund $57.7 million of Pulte Mortgage’s financing needs via a repurchase agreement with the Company.
Pursuant to the two $100 million stock repurchase programs authorized by our 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), we have repurchased a total of 9,688,900 shares for a total of $297.7 million. There have been no repurchases under these programs since 2006. However, we announced in September 2010 our intention to initiate a minimum $50.0 million per year stock repurchase program under our existing authorization. The repurchases may be implemented using a variety of methods, and timing will be dependent on prevailing market conditions, alternative uses of capital, and other factors. We had remaining authorization to purchase common stock aggregating $102.3 million at September 30, 2010.
For the last three years, we have generated significant positive cash flow primarily through the liquidation of land inventory without a corresponding level of reinvestment combined with refunds of income taxes paid in prior years. We have used this positive cash flow to, among other things, increase our cash reserves as well as retire outstanding debt, including the completion of a tender offer for $500.0 million of senior notes on October 21, 2010. We do not anticipate that we will be able to continue to generate positive cash flow at these same levels in the near future. Additionally, should growth conditions return to the homebuilding industry, we will need to invest significant capital into our operations to support such growth.
Our net cash provided by operating activities for the nine months ended September 30, 2010 was $798.6 million compared with $330.5 million for the nine months ended September 30, 2009. During the nine months ended September 30, 2010, we received federal income tax refunds of $881.6 million compared with $362.0 million during the prior year period. After adjusting for these tax refunds, operating cash flow was slightly negative for the first nine months of 2010 and 2009. Generally, the primary drivers of cash flow from operations are inventory levels and profitability. For the nine months ended September 30, 2010 and 2009, our net loss was largely attributable to non-cash asset impairments, including land-related charges, investments in unconsolidated entities, and goodwill impairments. Cash flows from operations in 2010 were negatively impacted by an increase in inventory while 2009 benefited from a net decrease in inventory and residential mortgage loans available-for-sale.
Net cash used by investing activities was $19.3 million at September 30, 2010, compared to net cash provided by investing activities of $1.7 billion for the nine months ended September 30, 2009. The net cash used in 2010 was primarily the result of investments in unconsolidated entities and subsidiaries, partially offset by distributions from unconsolidated entities and an increase in residential mortgage loans held for investment. The net cash provided at September 30, 2009 was largely the result of cash acquired with the Centex merger.
Net cash used by financing activities totaled $14.3 million for the nine months ended September 30, 2010, primarily as the result of net repayments made under Financial Services credit arrangements and stock repurchases, offset by an increase in stock issued. Net cash used in financing activities for the nine months ended September 30, 2009 totaled $2.2 billion, largely attributable to the $2.0 billion used to retire outstanding debt combined with reductions in amounts outstanding under our Financial Services credit arrangements.
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 may also increase our financing, labor, and material costs. In addition, higher mortgage interest rates significantly affect the affordability of permanent mortgage financing to prospective homebuyers. While we attempt to pass on to our customers increases in our costs through increased sales prices, the current industry conditions have resulted in lower sales prices in many of our markets. If we are unable to raise sales prices enough to compensate for higher costs, or if mortgage interest rates increase significantly, affecting our prospective homebuyers’ ability to adequately finance home purchases, our revenues, gross margins, and net income would be adversely affected.
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Seasonality
We experience variability in our quarterly results from operations due to the seasonal nature of the homebuilding industry. Historically, we have experienced significant increases in revenues and cash flow from operations during the fourth quarter based on the timing of home settlements. Under current market conditions, however, it is difficult to determine whether these seasonal trends will continue.
Contractual Obligations
There have been no other material changes to our contractual obligations from those disclosed in our “Contractual Obligations” contained 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, 2009.
Off-Balance Sheet Arrangements
At September 30, 2010 and December 31, 2009, aggregate outstanding debt of unconsolidated joint ventures was $18.7 million and $69.5 million, respectively, of which our proportionate share of such joint venture debt was $6.4 million and $25.3 million, respectively. Of our proportionate share of joint venture debt, we provided limited recourse guaranties of $1.8 million for such joint venture debt at September 30, 2010 and $19.0 million at December 31, 2009. See Note 7 to the Condensed Consolidated Financial Statements included elsewhere in this Form 10-Q for additional information.
New Accounting Pronouncements
See Note 1 to the Condensed Consolidated Financial Statements included elsewhere in this Form 10-Q.
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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, 2010 compared with those contained 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, 2009, except as follows:
We have recorded a significant amount of goodwill related to the Centex merger completed in 2009. Goodwill, which represents the cost of acquired companies in excess of the fair value of the net assets at the acquisition date, is subject to annual impairment testing in the fourth quarter of each year or when events or changes in circumstances indicate the carrying amount may not be recoverable. In addition to our scheduled impairment test as of October 31, 2009, we performed an event-driven assessment as of September 30, 2010 in light of certain unfavorable indicators.
We test goodwill at the reporting unit level, which represents an operating segment or one level below. Because goodwill is assigned at the reporting unit level after an acquisition and reflects the current overall operating structure of the business, it no longer retains its association with a particular acquisition. We allocated goodwill resulting from the Centex merger to 24 reporting units, of which 23 reporting units related to our Homebuilding reporting segments and one reporting unit related to our Financial Services reporting segment. As a result of the impairment tests in the fourth quarter of 2009 and impairment tests in 2010, we have recorded cumulative impairments of the goodwill acquired with the Centex merger totaling $1.2 billion. As a result, our remaining goodwill totals $240.5 million at September 30, 2010 allocated amongst 13 of our Homebuilding reporting units. Goodwill for the other 11 reporting units included in the original allocation of goodwill has been written-off due to either impairment or disposal.
We evaluate the recoverability of goodwill by following a two step process. Step one of the goodwill impairment test involves comparing the carrying value of each of our reporting units to their estimated fair value. We determine the fair value of each reporting unit using accepted valuation methods, including the use of discounted cash flows supplemented by market-based assessments of fair value. The fair values are significantly impacted by estimates related to current market valuations, current and future economic conditions in each of our geographical markets, including the demand for new housing, and our strategic plans within each of our geographical markets. The discounted cash flow valuations involve the use of certain key assumptions, including projected revenue growth, profitability, and working capital levels as well as market-based discount rates (a discount rate of 10.0% was used for all reporting units in the 2010 and 2009 goodwill impairment tests based on a market-based weighted-average cost of capital for the homebuilding industry). In performing these valuations, we rely on our internal forecasts trended toward long-term averages that vary by reporting unit based on a combination of historical performance and our expectations for the future. Due to uncertainties in the estimation process and the significant volatility in demand for new housing, actual results could differ significantly from such estimates. As a result of step one of the September 2010 goodwill impairment test, we determined that the carrying value exceeded the fair value for the majority of our reporting units with goodwill. We perform step two of the goodwill impairment test for any reporting unit whose carrying value exceeds its fair value. Step two involves allocating the fair value of the reporting unit to its assets and liabilities, with the excess representing implied goodwill. An impairment loss is recognized if the recorded goodwill exceeds the implied goodwill. As a result of Step 2 at both September 30, 2010 and October 31, 2009, we determined that a significant portion of our goodwill balance was impaired.
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Critical Accounting Policies and Estimates (continued)
Goodwill (continued)
The below table summarizes our September 30, 2010 goodwill impairment test results ($000’s omitted):
(a) Goodwill impairment recorded
(b) Step two performed but goodwill not impaired
(c) Fair value exceeded carrying value by greater than 10%
As reflected in the above table, $228.0 million of the goodwill remaining at September 30, 2010 (the sum of lines (a) and (b)) relates to goodwill allocated to 11 reporting units that are at increased risk of future impairment. Our overall outlook and cash flow projections for each reporting unit involve the use of certain key assumptions, many of which are interdependent upon each other. A change in any one or combination of these assumptions could impact the estimated fair value of a reporting unit. If our expectations of future results and cash flows decrease significantly or other economic conditions deteriorate, goodwill may be further impaired. Also, while not directly triggering an impairment of goodwill, a significant decrease in the Company’s market capitalization in the future may indicate that the fair value of one or more of the Company’s reporting units has decreased. Should subsequent analysis confirm that a decrease has occurred for one or more reporting units, an impairment of goodwill may result. A hypothetical 10% decrease in the fair value of each reporting unit would have resulted in an additional impairment loss of approximately $159.9 million related to the 11 reporting units with goodwill balances remaining at September 30, 2010.
The below table summarizes the goodwill at increased risk of future impairment by reportable segment as of September 30, 2010 ($000’s omitted):
We will continue to monitor each of our reporting units and perform goodwill impairment testing when events or changes in circumstances indicate the carrying amount may not be recoverable. See Note 3 to the Condensed Consolidated Financial Statements for additional discussion of our goodwill impairment.
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Adjustments to estimated reserves are recorded in the period in which the change in estimate occurs. The Company’s recorded reserves for all general liability insurance claims totaled $782.8 million and $513.0 million at September 30, 2010 and December 31, 2009, respectively. The recorded reserves include an actuarial assessment of incurred but not reported claims, which represent approximately 78% and 75% of the total general liability reserves at September 30, 2010 and December 31, 2009, respectively. Changes in the number and timing of reported claims and the estimates of specific claim values will significantly impact estimates of future reserves, which are reflected by the incurred but not reported reserve.
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, 2010, our rate-sensitive financing obligations, principal cash flows by scheduled maturity, weighted-average interest rates, and estimated fair values ($000’s omitted):
Rate-sensitive liabilities:
Fixed interest rate debt:
Average interest rate
Limited recourse collateralized financing
Qualitative disclosure:
There has been no material change to the qualitative disclosure found in Item 7A, Quantitative and Qualitative Disclosures about Market Risk, of our Annual Report on Form 10-K for the year ended December 31, 2009.
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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 are subject to a number of risks, uncertainties and other factors that could cause our actual results, performance, prospects or opportunities, as well as those of the markets we serve or intend to serve, to differ materially from those expressed in, or implied by, these statements. You can identify these statements by the fact that they do not relate to matters of a strictly factual or historical nature and generally discuss or relate to forecasts, estimates or other expectations regarding future events. Generally, the words “believe,” “expect,” “intend,” “estimate,” “anticipate,” “project,” “may,” “can,” “could,” “might,” “will” and similar expressions identify forward-looking statements, including statements related to expected operating and performing results, planned transactions, planned objectives of management, future developments or conditions in the industries in which we participate and other trends, developments and uncertainties that may affect our business in the future.
Such risks, uncertainties and other factors include, among other things: interest rate changes and the availability of mortgage financing; continued volatility in, and potential deterioration of, the debt and equity markets; competition within industries in which PulteGroup operates; the availability and cost of land and other raw materials used by PulteGroup in its homebuilding operations; the availability and cost of insurance covering risks associated with PulteGroup’s businesses; shortages and the cost of labor; weather related slowdowns; slow growth initiatives and/or local building moratoria; governmental regulation directed at or affecting the housing market, the homebuilding industry or construction activities; uncertainty in the mortgage lending industry, including revisions to underwriting standards and repurchase requirements associated with the sale of mortgage loans; the interpretation of or changes to tax, labor and environmental laws; economic changes nationally or in PulteGroup’s local markets, including inflation, deflation, changes in consumer confidence and preferences and the state of the market for homes in general; legal or regulatory proceedings or claims; required accounting changes; terrorist acts and other acts of war; and other factors of national, regional and global scale, including those of a political, economic, business and competitive nature. See the Company’s Annual Report on Form 10-K and Annual Report to Shareholders for the year ended December 31, 2009 and other public filings with the Securities and Exchange Commission for a further discussion of these and other risks and uncertainties applicable to PulteGroup’s business. PulteGroup undertakes no duty to update any forward-looking statement whether as a result of new information, future events or changes in PulteGroup’s expectations.
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Management, including our Chairman, President and Chief Executive Officer and Executive Vice President and Chief Financial Officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of September 30, 2010. Based upon, and as of the date of, that evaluation, our Chairman, President and Chief Executive Officer and Executive Vice President and Chief Financial Officer concluded that the disclosure controls and procedures were effective as of September 30, 2010.
Management is responsible for establishing and maintaining effective internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). There was no change in our internal control over financial reporting during the quarter ended September 30, 2010 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
PART II. OTHER INFORMATION
Issuer Purchases of Equity Securities
July 1, 2010 to July 31, 2010
August 1, 2010 to August 31, 2010
September 1, 2010 to September 30, 2010
Total
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Exhibit Number and Description
2(a)
3(a)
3(b)
3(c)
3(d)
3(e)
4(a)
4(b)
10(a)
31(a)
31(b)
101.INS
101.SCH
101.CAL
101.LAB
101.PRE
101.DEF
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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.
Date: November 5, 2010
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