PULTEGROUP INC/MI/
ITEM 1A. RISK FACTORS
Discussion of our business and operations included in this annual report on Form 10-K should be read together with the risk factors set forth below. They describe various risks and uncertainties to which we are, or may become, subject. These risks and uncertainties, together with other factors described elsewhere in this report, have the potential to affect our business, financial condition, results of operations, cash flows, strategies, or prospects in a material and adverse manner.
Downward changes in general economic, real estate construction, or other business conditions could adversely affect our business or our financial results.
The residential homebuilding industry is sensitive to changes in economic conditions and other factors, such as the level of employment, consumer confidence, consumer income, availability of financing, and interest rate levels. Adverse changes in any of these conditions generally, or in the markets where we operate, could decrease demand and pricing for new homes in these areas or result in customer cancellations of pending contracts, which could adversely affect the number of home deliveries we make or reduce the prices we can charge for homes, either of which could result in a decrease in our revenues and earnings and would adversely affect our financial condition.
The homebuilding industry is currently experiencing an economic down cycle, which has had an adverse effect on our business and results of operations.
Prior to 2006, land and home prices rose significantly in many of our markets. Since early 2006, the U.S. housing market has been unfavorably impacted by severe weakness in new home sales attributable to, among other factors, weak consumer confidence, tightened mortgage standards, significant foreclosure activity, a more challenging appraisal environment, higher than normal unemployment levels, and significant uncertainty in the global economy. These conditions have contributed to sharply weakened demand for new homes and heightened pricing pressures on new and existing home sales. As a result of these factors, we have experienced significant decreases in our revenues and profitability. We have also incurred substantial impairments of our land inventory and certain other assets. We cannot predict the duration or the severity of the current market conditions, nor provide any assurances that the adjustments we have made in our operating strategy to address these conditions will be successful.
If the market value of our land and homes drops significantly, our profits could decrease.
The market value of land, building lots and housing inventories can fluctuate significantly as a result of changing market conditions and the measures we employ to manage inventory risk may not be adequate to insulate our operations from a severe drop in inventory values. We acquire land for expansion into new markets and for replacement of land inventory and expansion within our current markets. If housing demand decreases below what we anticipated when we acquired our inventory, we may not be able to make profits similar to what we have made in the past, we may experience less than anticipated profits, and/or we may not be able to recover our costs when we sell and build homes. When market conditions are such that land values are not appreciating, option arrangements previously entered into may become less desirable, at which time we may elect to forego deposits and pre-acquisition costs and terminate the agreement. In the face of adverse market conditions, we may have substantial inventory carrying costs, we may have to write down our inventory to its fair value, and/or we may have to sell land or homes at a loss.
As a result of the changing market conditions in the homebuilding industry that have occurred since early 2006, we incurred significant land-related charges resulting from the write-off of deposits and pre-acquisition costs related to land transactions we elected not to pursue, net realizable valuation adjustments related to land positions sold or held for sale, impairments on land assets related to communities under development or to be developed in the future, impairments of our investments in unconsolidated joint ventures, and impairments of our recorded goodwill. It is reasonably possible that the estimated cash flows from our projects may change and could result in a future need to record additional valuation adjustments. Additionally, if conditions in the homebuilding industry or our local markets worsen in the future, if the current difficult market conditions extend beyond our expectations, or if our strategy related to certain communities changes, we may be required to evaluate our assets for additional impairments or write-downs, which could result in additional charges that might be significant.
Our success depends on our ability to acquire land suitable for residential homebuilding at reasonable prices, in accordance with our land investment criteria.
The homebuilding industry is highly competitive for suitable land. The availability of finished and partially finished developed lots and undeveloped land for purchase that meet our internal criteria depends on a number of factors outside our control, including land availability in general, competition with other homebuilders and land buyers for desirable property, inflation in land prices, zoning, allowable housing density, and other regulatory requirements. Should suitable lots or land become less available, the number of homes we may be able to build and sell could be reduced, and the cost of land could be increased, perhaps substantially, which could adversely impact our results of operations.
Our long-term ability to build homes depends on our acquiring land suitable for residential building at reasonable prices in locations where we want to build. In the past, we experienced significant competition for suitable land as a result of land constraints in many of our markets. As competition for suitable land increases, and as available land is developed, the cost of acquiring suitable remaining land could rise, and the availability of suitable land at acceptable prices may decline. Any land shortages or any decrease in the supply of suitable land at reasonable prices could limit our ability to develop new communities or result in increased land costs. We may not be able to pass through to our customers any increased land costs, which could adversely impact our revenues, earnings, and margins.
We are subject to claims related to mortgage loans we sold in the secondary mortgage market that may be significant.
Our mortgage operations may be responsible for losses associated with mortgage loans originated and sold to investors in the event of errors or omissions relating to certain representations and warranties that the loans sold meet certain requirements, including representations as to underwriting standards, the type of collateral, the existence of primary mortgage insurance, and the validity of certain borrower representations in connection with the loan. We may also be required to indemnify underwriters that purchased and securitized loans originated by a former subsidiary of Centex for losses incurred by investors in those securitized loans based on similar breaches of representations and warranties.
To date, the significant majority of these losses relate to loans originated in 2006 and 2007, during which period inherently riskier loan products became more common in the origination market. In 2006 and 2007, we originated $39.5 billion of loans, excluding loans originated by Centex's former subprime loan business sold by Centex in 2006.
In addition, we entered into an agreement in conjunction with the wind down of Centex’s mortgage operations, which ceased loan origination activities in December 2009, that provides a guaranty for one major investor of loans originated by Centex. This guaranty provides that we will honor the potential repurchase obligations of Centex’s mortgage operations related to breaches of similar representations in the origination of a certain pool of loans.
The resolution of claims related to alleged breaches of these representations and warranties and repurchase claims could have a material adverse effect on our financial condition, cash flows and results of operations, and could exceed existing estimates and accruals. The repurchase liability we recorded is estimated based on several factors, including the level of current unresolved repurchase requests, the volume of estimated probable future repurchase requests, our ability to cure the defects identified in the repurchase requests, and the severity of the estimated loss upon repurchase. The factors referred to above are subject to change in light of market developments, the economic environment, and other circumstances, some of which are beyond our control. Accordingly, there can be no assurance that such reserves will not need to be increased in the future.
Future increases in interest rates, reductions in mortgage availability, or increases in the effective costs of owning a home could prevent potential customers from buying our homes and adversely affect our business and financial results.
A large majority of our customers finance their home purchases through mortgage loans, many through our mortgage bank. Interest rates have been near historical lows for several years, which has made new homes more affordable. Increases in interest rates or decreases in the availability of mortgage financing, however, could reduce the market for new homes. Potential homebuyers may be less willing or able to pay the increased monthly costs or to obtain mortgage financing that exposes them to interest rate changes. Lenders may increase the qualifications needed for mortgages or adjust their terms to address any increased credit risk. Even if potential customers do not need financing, changes in interest rates and mortgage availability could make it harder for them to sell their current homes to potential buyers who need financing. These factors could adversely affect the sales or pricing of our homes and could also reduce the volume or margins in our financial services business. Beginning in early 2007, the availability of certain mortgage financing products became more constrained as the mortgage industry began to more closely scrutinize sub-prime, Alt-A, and other non-conforming mortgage products. Our financial services business could also be impacted to the extent we are unable to match interest rates and amounts on loans we have committed to originate through the various hedging strategies we employ. These developments have had, and may continue to have, a material adverse effect on the overall demand for new housing and thereby on the results of operations for our homebuilding business.
In addition, the Federal Reserve has purchased a sizeable amount of mortgage-backed securities in part to stabilize mortgage interest rates and to support the market for mortgage-backed securities. As the Federal Reserve reduces its holdings of mortgage-backed securities over time, the availability and affordability of mortgage loans, including the consumer interest rates for such loans, could be adversely affected.
We also believe that the availability of FHA and VA mortgage financing is an important factor in marketing some of our homes. The FHA has and may continue to impose stricter loan qualification standards, raise minimum down payment requirements, impose higher mortgage insurance premiums and other costs, and/or limit the number of mortgages it insures. The liquidity provided by Fannie Mae and Freddie Mac to the mortgage industry is also critical to the housing market. The impact of the federal government’s conservatorship of Fannie Mae and Freddie Mac on the short-term and long-term demand for new housing remains unclear. Any limitations or restrictions on the availability of financing by these agencies could adversely affect interest rates, mortgage financing, and our sales of new homes and mortgage loans.
Significant costs of homeownership include mortgage interest expense and real estate taxes, both of which are generally deductible for an individual’s federal and, in some cases, state income taxes. Any changes to income tax laws by the federal government or a state government to eliminate or substantially reduce these income tax deductions, as has been considered from time to time, would increase the after-tax cost of owning a home. Increases in real estate taxes by local governmental authorities also increase the cost of homeownership. Any such increases to the cost of homeownership could adversely impact the demand for and sales prices of new homes.
Adverse capital and credit market conditions may significantly affect our access to capital and cost of capital.
The capital and credit markets have experienced significant volatility in recent years. In many cases, the markets have exerted downward pressure on the availability of liquidity and credit capacity for issuers. We need liquidity for future growth and development of our business. Without sufficient liquidity, we may not be able to purchase additional land or develop land, which could adversely affect our financial results. At December 31, 2011, we had cash and equivalents of $1.1 billion as well as restricted cash totaling $101.9 million. However, our internal sources of liquidity may prove to be insufficient, and in such case, we may not be able to successfully obtain additional financing on terms acceptable to us, or at all.
Another source of liquidity includes our ability to use letters of credit and surety bonds pursuant to certain performance-related obligations and as security for certain land option agreements and under various insurance programs. The majority of these letters of credit and surety bonds are in support of our land development and construction obligations to various municipalities, other government agencies, and utility companies related to the construction of roads, sewers, and other infrastructure. At December 31, 2011, we had outstanding letters of credit and surety bonds totaling $235.9 million and $1.2 billion, respectively. Of these amounts outstanding, $83.2 million of the letters of credit were subject to cash-collateralized agreements while the remaining letters of credit and surety bonds were unsecured. If we are unable to obtain letters of credit or surety bonds when required, or the conditions imposed by issuers increase significantly, our financial condition and results of operations could be adversely affected.
Competition for homebuyers could reduce our deliveries or decrease our profitability.
The housing industry in the United States is highly competitive. We compete primarily on the basis of location, price, quality, reputation, design, community amenities, and our customers' overall sales and homeownership experiences. We compete in each of our markets with numerous national, regional, and local homebuilders. This competition with other homebuilders could reduce the number of homes we deliver or cause us to accept reduced margins in order to maintain sales volume.
We also compete with resales of existing or foreclosed homes, housing speculators, and available rental housing. Increased competitive conditions in the residential resale or rental market in the regions where we operate could decrease demand for new homes or unfavorably impact pricing for new homes.
Supply shortages and other risks related to the demand for skilled labor and building materials could increase costs and delay deliveries.
The homebuilding industry is highly competitive for skilled labor and materials. Additionally, the cost of certain building materials, especially lumber, steel, concrete, copper, and petroleum-based materials, is influenced by changes in global commodity prices. Increased costs or shortages of skilled labor and/or materials could cause increases in construction costs and construction delays. We may not be able to pass on increases in construction costs to customers and generally are unable to pass on any such increases to customers who have already entered into sales contracts as those sales contracts generally fix the price of the home at the time the contract is signed, which may be well in advance of the construction of the home. Sustained increases in construction costs may, over time, erode our margins, and pricing competition for materials and labor may restrict our ability to pass on any such additional costs, thereby decreasing our margins.
Our income tax provision and tax reserves may be insufficient if a taxing authority is successful in asserting positions that are contrary to our interpretations and related reserves, if any.
Significant judgment is required in determining our provision for income taxes and our reserves for federal, state, and local taxes. In the ordinary course of business, there may be matters for which the ultimate outcome is uncertain. Our evaluation is based on a number of factors, including changes in facts or circumstances, changes in tax law, correspondence with tax authorities during the course of audits, and effective settlement of audit issues. Although we believe our approach to determining the tax treatment is appropriate, no assurance can be given that the final tax authority review will not be materially different than that which is reflected in our income tax provision and related tax reserves. Such differences could have a material adverse effect on our income tax provision in the period in which such determination is made and, consequently, on our net income for such period.
We are periodically audited by various federal, state, and local authorities regarding tax matters. Our current audits are in various stages of completion; however, no outcome for a particular audit can be determined with certainty prior to the conclusion of the audit, appeal and, in some cases, litigation process. As each audit is concluded, adjustments, if any, are appropriately recorded in our financial statements in the period determined. To provide for potential tax exposures, we maintain tax reserves based on reasonable estimates of potential audit results. If these reserves are insufficient upon completion of an audit, there could be an adverse impact on our financial position and results of operations.
We may not realize our deferred income tax assets.
The ultimate realization of our deferred income tax assets is dependent upon generating future taxable income and executing tax planning strategies. We have recorded valuation allowances against our deferred income tax assets. The valuation allowance will fluctuate as conditions change.
Our ability to utilize net operating losses (“NOLs”), built-in losses (“BILs”), and tax credit carryforwards to offset our future taxable income would be limited if we were to undergo an “ownership change” within the meaning of Section 382 of the Internal Revenue Code (the “IRC”). In general, an “ownership change” occurs whenever the percentage of the stock of a corporation owned by “5-percent shareholders” (within the meaning of Section 382 of the IRC) increases by more than 50 percentage points over the lowest percentage of the stock of such corporation owned by such “5-percent shareholders” at any time over the testing period.
An ownership change under Section 382 of the IRC would establish an annual limitation to the amount of NOLs, BILs, and tax credit carryforwards we could utilize to offset our taxable income in any single year. The application of these limitations might prevent full utilization of the deferred tax assets attributable to our NOLs, BILs, and tax credit carryforwards. We have not experienced an ownership change as defined by Section 382. To preserve our ability to utilize NOLs, BILs, and other tax benefits in the future without a Section 382 limitation, we adopted a shareholder rights plan, which is triggered upon certain transfers of our securities, and amended our by-laws to prohibit certain transfers of our securities. Notwithstanding the foregoing measures, there can be no assurance that we will not undergo an ownership change within the meaning of Section 382.
As a result of the merger with Centex, our ability to use certain of Centex’s pre-ownership change NOLs, BILs, or deductions is limited under Section 382 of the Internal Revenue Code. The applicable Section 382 limitation is approximately $67.4 million per year for NOLs, losses realized on built-in loss assets that are sold within 60 months of the ownership change, and certain deductions. The limitation may result in a significant portion of Centex’s pre-ownership change NOLs, BILs, and tax credit carryforwards or deductions not being available for our use.
The value of our deferred tax assets is also dependent upon the tax rates in effect at the time taxable income is expected to be generated. A decrease in enacted corporate tax rates in our major jurisdictions, especially the U.S. federal corporate tax rate, would decrease the value of our deferred tax assets, which could be material.
We have significant intangible assets. If these assets become impaired, then our profits and shareholders’ equity may be reduced.
We have significant intangible assets related to prior business combinations. We evaluate the recoverability of intangible assets whenever facts and circumstances indicate the carrying amount may not be recoverable. If the carrying value of intangible assets is deemed impaired, the carrying value is written down to fair value. This would result in a charge to our operating earnings. If management’s expectations of future results and cash flows decrease significantly, impairments of the remaining intangible assets may occur.
Government regulations could increase the cost and limit the availability of our development and homebuilding projects or affect our related financial services operations and adversely affect our business or financial results.
Our operations are subject to building, environmental, and other regulations imposed and enforced by various federal, state, and local governing authorities. For our homes to qualify for FHA or VA mortgages, we must satisfy valuation standards and site, material, and construction requirements of those agencies. Our compliance with federal, state, and local laws relating to protection of the environment has had, to date, no material effect upon capital expenditures, earnings, or competitive position. More stringent requirements could be imposed in the future on homebuilders and developers, thereby increasing the cost of compliance.
New housing developments may be subject to various assessments for schools, parks, streets, and other public improvements. These can cause an increase in the effective prices for our homes.
We also are subject to a variety of local, state, and federal laws and regulations concerning protection of health, safety, and the environment. The impact of environmental laws varies depending upon the prior uses of the building site or adjoining properties and may be greater in areas with less supply where undeveloped land or desirable alternatives are less available. These matters may result in delays, may cause us to incur substantial compliance, remediation and other costs, and can prohibit or severely restrict development and homebuilding activity in environmentally sensitive regions or areas.
Our financial services operations are also subject to numerous federal, state, and local laws and regulations. These include eligibility requirements for participation in federal loan programs and compliance with consumer lending and similar requirements such as disclosure requirements, prohibitions against discrimination, and real estate settlement procedures. They may also subject our operations to examination by applicable agencies, pursuant to which those agencies may limit our ability to provide mortgage financing or title services to potential purchasers of our homes.
Homebuilding is subject to warranty and other claims in the ordinary course of business that can be significant.
As a homebuilder, we are subject to home warranty, construction defect, and other claims arising in the ordinary course of business. We record warranty and other reserves for the homes we sell based on historical experience in our markets and our judgment of the qualitative risks associated with the types of homes built. We have, and require our subcontractors to have, general liability, property, errors and omissions, workers compensation, and other business insurance. These insurance policies protect us against a portion of our risk of loss from claims, subject to certain self-insured per occurrence and aggregate retentions, deductibles, and available policy limits. We reserve for costs to cover our self-insured and deductible amounts under these policies and for any costs of claims and lawsuits based on an analysis of our historical claims, which includes an estimate of claims incurred but not yet reported. Because of the uncertainties inherent in these matters, we cannot provide assurance that our insurance coverage, our subcontractor arrangements, and our reserves will be adequate to address all our warranty and construction defect claims in the future. Contractual indemnities can be difficult to enforce, we may be responsible for applicable self-insured retentions, and some types of claims may not be covered by insurance or may exceed applicable coverage limits. Additionally, the coverage offered by and the availability of general liability insurance for construction defects are currently costly and limited. We have responded to the recent increases in insurance costs and coverage limitations by increasing our self-insured retentions and claim reserves. There can be no assurance that coverage will not be further restricted and become more costly. Additionally, we are exposed to counterparty default risk related to our and our subcontractors’ insurance carriers.
Natural disasters and severe weather conditions could delay deliveries, increase costs, and decrease demand for new homes in affected areas.
Our homebuilding operations are located in many areas that are subject to natural disasters and severe weather. The occurrence of natural disasters or severe weather conditions can delay new home deliveries, increase costs by damaging inventories, reduce the availability of materials, and negatively impact the demand for new homes in affected areas. Furthermore, if our insurance does not fully cover business interruptions or losses resulting from these events, our earnings, liquidity, or capital resources could be adversely affected.
Inflation may result in increased costs that we may not be able to recoup if demand declines.
Inflation can have a long-term impact on us because increasing costs of land, materials, and labor may require us to increase the sales prices of homes in order to maintain satisfactory margins. In addition, inflation is often accompanied by higher interest rates, which have a negative impact on housing demand, in which case we may not be able to raise home prices sufficiently to keep up with the rate of inflation and our margins could decrease.
Future terrorist attacks against the United States or increased domestic and international instability could have an adverse effect on our operations.
A future terrorist attack against the U.S. could cause a sharp decrease in the number of new contracts signed for homes and an increase in the cancellation of existing contracts. Accordingly, adverse developments in the war on terrorism, future terrorist attacks against the U.S., or increased domestic and international instability could adversely affect our business.
ITEM 1B. UNRESOLVED STAFF COMMENTS
This Item is not applicable.
ITEM 2. PROPERTIES
Our homebuilding and corporate headquarters are located in leased office facilities at 100 Bloomfield Hills Parkway, Bloomfield Hills, Michigan 48304. Pulte Mortgage leases its primary office facilities in Englewood, Colorado, and we also maintain various support functions in leased facilities near Phoenix, Arizona. Our homebuilding divisions and financial services branches lease office space in the geographic locations in which they conduct their day-to-day operations.
Because of the nature of our homebuilding operations, significant amounts of property are held as inventory in the ordinary course. Such properties are not included in response to this Item.
ITEM 3. LEGAL PROCEEDINGS
We are involved in various legal and governmental proceedings incidental to our continuing business operations, many involving claims related to certain construction defects. The consequences of these matters are not presently determinable but, in our opinion, after consulting with legal counsel and taking into account insurance and reserves, the ultimate liability is not expected to have a material adverse impact on our results of operations, financial position, or cash flows. However, to the extent the liability arising from the ultimate resolution of any matter exceeds our estimates reflected in the recorded reserves relating to such matter, we could incur additional charges that could be significant.
ITEM 4. MINE SAFETY DISCLOSURES
This Item is not applicable.
ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT
Set forth below is certain information with respect to our executive officers.
The following is a brief account of the business experience of each officer during the past five years:
Mr. Dugas was appointed Chairman in August 2009 and President and Chief Executive Officer in July 2003. Prior to that time, he served as Executive Vice President and Chief Operating Officer. He was appointed Chief Operating Officer in May 2002 and Executive Vice President in December 2002. Since joining our company in 1994, he has served in a variety of management positions.
Mr. O'Shaughnessy was appointed Executive Vice President and Chief Financial Officer in May 2011. Prior to joining our company, he held a number of financial roles at Penske Automotive Group from 1997 to 2011, most recently as Executive Vice President and Chief Financial Officer.
Mr. Ellinghausen was appointed Executive Vice President, Human Resources in December 2006.
Ms. Meyer was appointed Senior Vice President and Chief Marketing Officer in September 2009. Prior to joining our company, Ms. Meyer held various senior marketing positions, most recently serving as Vice President and Chief Marketing Officer for Chrysler, LLC from August 2007 to December 2008. Prior to joining Chrysler, LLC, Ms. Meyer held various marketing positions at Toyota Motor Sales from 2001 to 2007, most recently as Vice President of Marketing for Lexus.
Mr. Cook was appointed Senior Vice President, General Counsel and Secretary in December 2008 and previously held the position of Vice President, General Counsel and Secretary since February 2006.
Mr. Bertero was appointed Area President, East in August 2009. Prior to joining our company, Mr. Bertero was a regional executive vice president with Centex Corporation since 2006.
Mr. Smith was appointed Area President, Gulf Coast in 2008 and has served as an Area President over various geographical markets since 2006.
Mr. Beirne was appointed Area President, Central in 2012 and has served as an Area President over various geographical markets since 2006.
Mr. Chadwick was appointed Area President, Southwest in 2012 and previously held the position of Division President for our Arizona division. Since 2006, Mr. Chadwick has held the position of Area President or Division President over various geographical markets.
Mr. Schweninger was appointed Vice President and Controller effective March 2009. Since joining our company in 2005, he also has held the positions of Director - Finance & Accounting Process Improvement and Director of Corporate Audit.
There is no family relationship between any of the officers. Each officer serves at the pleasure of the Board of Directors.
PART II
ITEM 5.
MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Our common shares are listed on the New York Stock Exchange (Symbol: PHM).
Related Stockholder Matters
The table below sets forth, for the quarterly periods indicated, the range of high and low closing prices and cash dividends declared per share.
At February 1, 2012, there were 3,106 shareholders of record.
Issuer Purchases of Equity Securities (1)
(1)
Pursuant to the two $100 million stock repurchase programs authorized and announced by our Board of Directors in October 2002 and October 2005 and the $200 million stock repurchase authorized and announced 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. There are no expiration dates for the programs.
(2)
During the fourth quarter of 2011, a total of 134,219 shares were surrendered by employees for payment of minimum tax obligations upon the vesting of restricted stock. Such shares were not repurchased as part of our publicly-announced stock repurchase programs.
The information required by this item with respect to equity compensation plans is set forth under Item 12 of this annual report on Form 10-K and is incorporated herein by reference.
Performance Graph
The following line graph compares for the fiscal years ended December 31, 2007, 2008, 2009, 2010, and 2011 (a) the yearly cumulative total shareholder return (i.e., the change in share price plus the cumulative amount of dividends, assuming dividend reinvestment, divided by the initial share price, expressed as a percentage) on PulteGroup’s common shares, with (b) the cumulative total return of the Standard & Poor’s 500 Stock Index, and with (c) the Dow Jones U.S. Select Home Construction Index. The Dow Jones U.S. Select Home Construction Index is a widely-recognized index comprised primarily of large national homebuilders. We believe comparison of our shareholder return to this index represents a meaningful analysis for investors.
COMPARISON OF FIVE YEAR CUMULATIVE TOTAL RETURN*
AMONG PULTEGROUP, INC., S&P 500 INDEX, AND PEER INDEX
Fiscal Year Ended December 31, 2011
* Assumes $100 invested on December 31, 2006, and the reinvestment of dividends.
ITEM 6. SELECTED FINANCIAL DATA
Set forth below is selected consolidated financial data for each of the past five fiscal years. The selected financial data should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations and our Consolidated Financial Statements and Notes thereto included elsewhere in this report.
(a)
Income (loss) from discontinued operations is comprised of our former thrift operation and Argentina and Mexico homebuilding operations, which have been presented as discontinued operations for all periods presented.
(b)
Includes Centex’s operations since August 18, 2009.
(a)
Homebuilding interest expense, which represents the amortization of capitalized interest, and land and community valuation adjustments are included in home sale cost of revenues.
(b)
Includes Centex’s operations since August 18, 2009.
ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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.
The U.S. housing market and broader economy remain in a period of uncertainty. While we have experienced some stabilization in our local markets, homebuilding industry volumes remain at near historically low levels. This more stable environment has resulted in a significant reduction in the level of land-related charges recorded during 2011 compared with recent years. However, significant short-term uncertainty remains such that we are not anticipating a broad recovery in homebuilding in the near term. Factors that are currently impacting the homebuilding industry negatively include:
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High levels of unemployment and associated low levels of consumer confidence;
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Continued high levels of foreclosure activity;
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Increased costs and standards related to FHA loans, which are a significant source of customer financing; and
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Uncertainty regarding the potential impacts of reforms to the overall U.S. financial services and mortgage industries, including the Dodd-Frank Wall Street Reform and Consumer Protection Act enacted into law on July 21, 2010; potential limitations on the mortgage interest income tax deduction; and potential future restructurings of Fannie Mae and Freddie Mac.
During 2011, we experienced a return to a somewhat more traditional demand pattern as new orders were higher in the first half of the year and home closings increased in each quarter throughout the year. While our overall volumes in 2011 were moderately lower than in 2010, the combination of improved gross margins, a more efficient overhead structure, and lower asset impairment charges resulted in a significant improvement in our bottom line results. We believe that improved employment levels and consumer confidence are necessary to unlock the pent-up demand that we believe has built up in recent years. 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 also positioning ourselves to capitalize upon growth when industry conditions improve. While we are purchasing land positions where it makes strategic and economic sense to do so, the opportunity to purchase developed lots in premium locations has become more limited and competitive in many of our markets. We also continue to evaluate each of our existing land parcels 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, including a further consolidation of our field organization and select corporate functions during 2011. Due to the persistence of these difficult market conditions, maintaining an efficient overhead structure will continue to be a significant area of focus. We are also adjusting the content in our homes to provide our customers more affordable alternatives and are building homes with smaller floor plans in certain of our communities.
Our outlook is cautious for 2012 as the timing of a sustainable recovery in the homebuilding industry remains uncertain. In the long-term, we continue to believe that the national publicly-traded builders will have a competitive advantage over local builders through their ability to leverage economies of scale, access to more reliable and lower cost financing through the capital markets, ability to control and entitle large land positions, and greater geographic and product diversification. Among the national publicly-traded peer group, we believe that builders with more significant land positions, broad geographic and product diversity, and sustainable capital positions will benefit as market conditions recover. In the short-term, we expect that market conditions will remain challenging, and our visibility as to future earnings performance is limited. Our evaluations for land-related charges recorded to date were based on our best estimates of the future cash flows for our communities. If conditions in the homebuilding industry or our local markets worsen in the future, if the current difficult market conditions extend beyond our expectations, or if our strategy related to certain communities changes, we may be required to evaluate our assets 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 ($000's omitted, except per share data):
*
Amounts previously classified as "non-operating" have been reclassified to "Homebuilding" (see to the Consolidated Financial Statements).
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The losses experienced by Homebuilding in 2011, 2010, and 2009 resulted primarily from significant charges related to the following ($000's omitted):
For additional information on each of the above, see the applicable Notes to the Consolidated Financial Statements.
Merger-related costs represent transaction and integration costs resulting directly from the Centex merger. In total, Homebuilding incurred $129.1 million of such costs in 2009. These costs consisted of $57.0 million of restructuring costs (primarily severance and lease exit costs) included in the above table within restructuring costs plus $72.1 million of investment banking and other professional fees, amortization of certain fair value adjustments, and certain other integration costs.
In addition to the above charges, Homebuilding continued to experience low volumes in 2009 through 2011. The revenue decline for the year ended December 31, 2011 was due in part to the impact of a federal homebuyer tax credit that existed during the first half of 2010 as well as lower average selling prices and fewer active communities in 2011. The lower revenue in 2011 and 2010 was partially offset by improved gross margins, reduced overhead costs, and lower impairment charges.
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The Financial Services loss in 2011 compared to income in 2010 was due to lower volumes and increased loss reserves related to loans originated in previous years. Such loss reserves totaled $59.3 million in 2011, compared with $16.9 million in 2010 (see Note 15 to the Consolidated Financial Statements). Financial Services income in 2010 was improved from 2009 primarily due to reduced loan loss reserves, which totaled $60.9 million in 2009. The Financial Services loss in 2009 also included certain integration costs directly related to the Centex merger totaling $8.4 million, which consisted primarily of severance benefits and lease exit and related asset impairment costs.
•
The income tax benefits in 2011 and 2010 were attributable primarily to the favorable resolution of certain federal and state income tax matters. The income tax benefit in 2009 reflected the impact of the Worker, Homeownership, and Business Assistance Act of 2009, which allowed us to carry back 2009 taxable losses to prior years and receive refunds of previously paid federal income taxes.
Homebuilding Operations
The following is a summary of income (loss) before income taxes for our Homebuilding operations ($000’s omitted):
(a)
Includes the amortization of capitalized interest. Home sale cost of revenues also includes land and community valuation adjustments of $15.9 million, $169.7 million, and $751.2 million for 2011, 2010, and 2009, respectively.
(b)
Includes net realizable value adjustments for land held for sale of $9.8 million, $39.1 million, and $113.7 million for 2011, 2010, and 2009, respectively.
(c)
SG&A for 2010 includes the adverse impact of insurance reserve adjustments totaling $280.4 million.
(d)
Includes impairments of our investments in unconsolidated joint ventures, which totaled $1.9 million and $54.1 million in 2010 and 2009, respectively.
(e)
Includes goodwill impairment charges of $240.5 million, $656.3 million, and $563.0 million in 2011, 2010, and 2009, respectively. Also includes the write-off of deposits and pre-acquisition costs for land option contracts we elected not to pursue of $10.0 million, $5.6 million, and $54.3 million in 2011, 2010, and 2009, respectively, and net losses related to the redemption of debt totaling $5.6 million, $38.9 million, and $31.6 million in 2011, 2010, and 2009, respectively.
(f)
Net new order dollars represent a composite of new order dollars combined with other movements of the dollars in backlog related to cancellations and change orders.
Centex merger
As indicated above, the Centex merger had a significant impact on our post-acquisition operating results. Centex was consolidated for the full year in our 2011 and 2010 operating results, however, if not for the impact of the Centex merger, our revenues, closings, and net new orders in 2010 would have experienced significant decreases from 2009. Our reported home sale revenues, closings, and net new orders for 2010 as reflected in the above tables represent decreases of 19%, 22%, and 28%, respectively, from the combined operating results of the two companies from 2009. However, these lower volumes were offset by lower land-related charges, improved gross margins and operating leverage, and our elimination of the substantial majority of duplicative overhead costs from the combined companies. Excluding the impact of the goodwill impairments and insurance-related losses recorded in 2010 and 2009, our Homebuilding income (loss) before income taxes in 2010 was significantly improved from the losses reported by either company or the combined companies in 2009. This illustrates the impact of the various actions we took to restructure our combined homebuilding operations into a more efficient organization as well as a somewhat more stable environment for the homebuilding industry, albeit at lower industry volumes.
Home sale revenues
Home sale revenues for 2011 were lower than 2010 by $469.1 million, or 11%. The decrease was attributable to an 11% decrease in closings as average selling prices remained stable from 2010 to 2011. The decline in closings for 2011 compared with 2010 occurred in each of our Homebuilding segments, except for Florida, and resulted primarily from lower industry volumes, in part due to the expiration of the federal homebuyer tax credit that existed during 2010 for orders under contract by April 30 and closed by September 30. This tax credit favorably impacted new orders and closings during the first half of 2010, in part we believe by pulling forward customer demand. The 11% decrease in our active communities also contributed to the lower closings.
Home sale revenues for 2010 were higher than 2009 by $550.5 million, or 14%. The increase in home sale revenues in 2010 over 2009 was attributable to a 14% increase in closings as average selling prices remained stable from 2009 to 2010. As discussed above under Centex merger, the increase in revenues in 2010 resulted from the Centex merger, which contributed $1.9 billion in 2010 compared to $1.1 billion in 2009. The federal homebuyer tax credit described above also contributed to increased revenues in the first half of 2010, which were partially offset by lower revenues in the second half of 2010.
Home sale gross margins
Home sale gross margins were 12.8% in 2011, compared with 9.4% in 2010 and (10.5)% in 2009. Gross margins during 2011 benefited from lower land and community valuation adjustments of $15.9 million, compared with $169.7 million and $751.2 million in 2010 and 2009, respectively. The benefit of these lower charges was partially offset by increased amortization of capitalized interest due to debt assumed with the Centex merger.
Gross margins were also adversely impacted in 2009 by a fair value adjustment related to homes under construction inventory acquired in the Centex merger. We recognized this fair value adjustment as an increase of $31.1 million to home sale cost of revenues as the related homes closed. The amortization of this adjustment was not significant in 2011 or 2010. Excluding the impact of land and community valuation adjustments, amortization of capitalized interest, and merger-related costs, adjusted home sale gross margins improved to 17.9% in 2011 from 16.7% in 2010 and 12.3% in 2009 (see the Non-GAAP Financial Measures section for a reconciliation of adjusted home sale gross margins). These improved gross margins reflect a combination of factors, including shifts in the product and geographic mix of homes closed, better alignment of our product offering with current market conditions, and a shift in our sales strategy toward more “pre-selling” of homes.
Land sales
We periodically elect to sell parcels of land to third parties in the event such assets no longer fit into our strategic operating plans or are zoned for commercial or other development. Land sale revenues and their related gains or losses vary between periods, depending on the timing of land sales and our strategic operating decisions. Land sales had margin contributions of $23.6 million, $(25.7) million, and $(113.9) million in 2011, 2010, and 2009, respectively. These margin contributions included net realizable value adjustments related to land held for sale totaling $9.8 million, $39.1 million, and $113.7 million in 2011, 2010, and 2009, respectively.
SG&A
In order to further reduce overhead costs and drive greater leverage, we reconfigured our organization during the fourth quarter of 2010 and again in the second quarter of 2011, consolidating certain local divisions. Along with these changes in our field operations, we also further reduced corporate and support staffing across a number of functions to further consolidate and streamline our operating processes. These actions were a continuation of a series of actions we have taken over the last several years to better align our overhead structure with expected volumes.
The gross dollar amount of our SG&A decreased $375.5 million, or 42%, in 2011 compared to 2010. SG&A, as a percentage of home sale revenues, was 13.2% in 2011, compared with 20.3% in 2010. SG&A in 2010 included $280.4 million in insurance reserve adjustments, substantially all of which related to general liability construction defect claims (see Note 15 to the Consolidated Financial Statements for additional discussion of insurance reserve adjustments). SG&A as a percentage of home sales revenues excluding these insurance reserve adjustments was 13.2% and 13.9% in 2011 and 2010, respectively. (See the Non-GAAP Financial Measures section for a reconciliation of SG&A as a percentage of home sale revenue, excluding insurance reserve adjustments). Excluding the insurance reserve adjustments from 2010, our SG&A declined significantly in gross dollars in 2011 and resulted in an improvement in overhead leverage. This improved overhead leverage resulted from a combination of better matching our overall cost structure with the current business environment and lower severance and equity compensation expense in 2011.
The gross dollar amount of our SG&A increased $222.7 million, or 33%, in 2010 compared to 2009. SG&A, as a percentage of home sale revenues, was 20.3% in 2010, compared with 17.4% in 2009. The increase in 2010 compared to 2009 was the result of the insurance reserve adjustments taken in 2010 noted above. SG&A as a percentage of home sales revenues excluding these insurance reserve adjustments was 13.9% and 17.4% in 2010 and 2009, respectively. This decrease resulted primarily from lower severance costs and the elimination of certain overhead costs directly related to the Centex merger that impacted 2009. In 2010, SG&A included severance costs of $22.3 million. During 2009, SG&A included transaction and integration costs related to the Centex merger, including severance costs, totaling $70.5 million, as well as certain duplicative corporate and divisional overhead costs during the transition period following the merger.
Equity in (earnings) loss of unconsolidated entities
Equity in (earnings) loss of unconsolidated entities was $(3.2) million, $(2.8) million, and $49.7 million, for 2011, 2010, and 2009, respectively. The primary cause for this change in results is the lower levels of impairments related to these entities recorded during 2011 and 2010 as compared to 2009. There were no impairments of investments in unconsolidated joint ventures in 2011, while impairments totaled $1.9 million and $54.1 million in 2010 and 2009, respectively. The majority of our unconsolidated entities represent land development joint ventures. As a result, the timing of income and losses varies between periods depending on the timing of transactions and circumstances specific to each entity.
Other expense (income), net
Other expense (income), net includes the following ($000’s omitted):
For additional information on each of the above, see the applicable Notes to the Consolidated Financial Statements. Miscellaneous expense (income), net includes $17.1 million in 2011 related to the write-down of a note receivable.
Interest income, net
The decrease in interest income, net in 2011 compared with 2010 resulted from lower invested cash balances that resulted primarily from the significant debt retirements we completed in 2011 and 2010. The slight decrease in interest income, net in 2010 compared with 2009 resulted from higher invested cash balances offset by lower interest rates. Additionally, $1.5 million of Homebuilding interest costs were expensed directly to interest expense in 2010 because our debt balance exceeded the amount of active inventory for certain periods and thus was not capitalized into inventory.
Net new orders
Net new order levels were essentially flat for 2011 compared with 2010. Net new orders reflect the impact of the federal homebuyer tax credit that expired during 2010, which favorably impacted new orders during the first half of 2010, and the reduced number of active communities in 2011. At December 31, 2011, we had 700 active communities, a decrease of 11% from December 31, 2010. The cancellation rate (canceled orders for the period divided by gross new orders for the period) for 2011 was unchanged from 2010 at 19%. Ending backlog, which represents orders for homes that have not yet closed, was essentially flat at December 31, 2011 compared with December 31, 2010, consistent with the overall new order levels.
For 2010, net new orders increased 7% compared with 2009 primarily due to incremental orders resulting from the Centex merger and the positive impact of the federal homebuyer tax credit in the first half of 2010, partially offset in the latter half of 2010 by a lower average sales pace per community. Excluding Centex, net new order units decreased moderately during 2010 due to the uncertainty in the overall U.S. housing industry. Cancellation rates were slightly lower in 2010 at 19%, compared to 23% in 2009. At December 31, 2010, we had 786 active selling communities, a decrease of 11% from December 31, 2009. Ending backlog at December 31, 2010 declined 33% from December 31, 2009 as the result of the lower community count and the impact of the federal homebuyer tax credit, which pulled forward demand into the first half of 2010.
Homes in production
The following is a summary of our homes in production at December 31, 2011 and 2010:
Included in our total homes in production were 2,862 and 3,494 homes that were unsold to customers (“spec homes”) at December 31, 2011 and 2010, respectively, of which 1,481 and 1,856 homes, respectively, were completed (“final specs”). The reduction in homes in production at December 31, 2011 compared to 2010 resulted primarily from our lower community count combined with a conscious effort to reduce the number of spec homes, especially final specs.
Controlled lots
The following is a summary of our lots under control at December 31, 2011 and 2010:
Of our controlled lots, 116,933 and 131,964 were owned and 10,060 and 10,082 were under option agreements approved for purchase at December 31, 2011 and 2010, respectively. In addition, there were 4,017 and 5,148 lots under option agreements pending approval at December 31, 2011 and 2010, respectively. While we are purchasing land positions where it makes strategic and economic sense to do so, the reduction in lots resulting from closings, land disposition activity, and withdrawals from land option contracts exceeded the number of lots added by new transactions during the year ended December 31, 2011.
The remaining purchase price related to land under option for use by our Homebuilding operations at future dates approximated $698.0 million at December 31, 2011. These land option agreements, which may be canceled at our discretion, and may extend over several years, are secured by deposits and pre-acquisition costs totaling $57.0 million, of which only $4.6 million is refundable. This balance excludes contingent payment obligations which may or may not become actual obligations to us.
Non-GAAP Financial Measures
This report contains information about our home sale gross margins and selling, general, and administrative expenses (“SG&A”) reflecting certain adjustments. These measures are considered non-GAAP financial measures under the SEC's rules and should be considered in addition to, rather than as a substitute for, the comparable GAAP financial measures as measures of our operating performance. Management and our local divisions use these measures in evaluating the operating performance of each community and in making strategic decisions regarding sales pricing, construction and development pace, product mix, and other daily operating decisions. We believe they are relevant and useful measures to investors for evaluating our performance through (1) gross profit generated on homes delivered during a given period and (2) the efficiency of our overhead cost structure and for comparing our operating performance to other companies in the homebuilding industry. Although other companies in the homebuilding industry report similar information, the methods used may differ. We urge investors to understand the methods used by other companies in the homebuilding industry to calculate gross margins and SG&A and any adjustments thereto before comparing our measures to that of such other companies.
The following tables set forth reconciliations of these non-GAAP financial measures to the GAAP financial measures that management believes to be most directly comparable ($000's omitted):
(a)
Write-offs of capitalized interest related to land and community valuation adjustments are reflected in capitalized interest amortization.
(b)
Home sale gross margin was adversely impacted by the amortization of a fair value adjustment to homes under construction inventory acquired with the Centex merger. This fair value adjustment is being amortized as an increase to home sale cost of revenues over the related home closings.
(a)
Adjustments to recorded insurance reserves, primarily related to general liability exposures.
Homebuilding Segment Operations
Our homebuilding operations represent our core business. Homebuilding offers a broad product line to meet the needs of homebuyers in our targeted markets. As of December 31, 2011, we conducted our operations in 61 markets located throughout 29 states. During 2011, we realigned our organizational structure and reportable segment presentation. Accordingly, the segment information provided herein has been reclassified to conform to the current presentation for all periods presented.
Northeast:
Connecticut, Delaware, Maryland, Massachusetts, New Jersey, New York, Pennsylvania,
Rhode Island, Virginia
Southeast:
Georgia, North Carolina, South Carolina, Tennessee
Florida:
Florida
Texas:
Texas
North:
Illinois, Indiana, Michigan, Minnesota, Missouri, Northern California, Ohio, Oregon, Washington
Southwest:
Arizona, Colorado, Hawaii, Nevada, New Mexico, Southern California
As part of the change in presentation, we removed the "Other non-operating" distinction. Amounts previously classified within "Other non-operating" have been reclassified to "Other homebuilding."
We also have one reportable segment for our financial services operations, which consist principally of mortgage banking and title operations. The Financial Services segment operates generally in the same markets as the Homebuilding segments.
The following table presents selected financial information for our reportable Homebuilding segments:
(a)
Other homebuilding includes the amortization of intangible assets, goodwill impairment, amortization of capitalized interest, net losses related to the redemption of debt, and other costs not allocated to the operating segments.
The following tables present additional selected financial information for our reportable Homebuilding segments:
The following table presents additional selected financial information for our reportable Homebuilding segments:
*
Land-related charges include land and community valuation adjustments, net realizable value adjustments for land held for sale, write-offs of deposits and pre-acquisition costs for land option contracts we elected not to pursue, and impairments of our investments in unconsolidated entities. See Notes 5 and 6 to the Consolidated Financial Statements for additional discussion of these charges.
Northeast:
For 2011, Northeast home sale revenues decreased 5% compared with 2010 due to a 10% decrease in closings offset in part by a 5% increase in the average selling price. The reduction in closing volumes was primarily due to fewer closings in our Mid-Atlantic division, in part due to a lower active community count. The decreased income before income taxes was primarily due to expense of $21.9 million in 2011 related to the write-down of a note receivable and the unfavorable resolution of certain contingencies. Such expense was partially offset by improved gross margin compared to the prior year. Land-related charges were comparable between periods, totaling $5.0 million in 2011, compared with $4.2 million in 2010. Net new order units increased 6% in 2011, led by our operations in the Northeast Corridor and Mid-Atlantic.
For 2010, Northeast home sale revenues increased 18% compared with 2009 due to a 19% increase in closings offset slightly by a 1% decrease in the average selling price. The majority of the increase in volumes resulted from increased sales in our Mid-Atlantic division. Excluding Centex, home sale revenues and closings decreased moderately, while average selling price increased slightly compared with 2009. The income before income taxes was primarily attributable to higher revenues, increased gross margin, improved overhead leverage compared with 2009, and a decrease in land-related charges to $4.2 million in 2010, compared with $201.9 million in 2009. Net new orders decreased 5% compared with 2009 due to decreased activity in our Northeast Corridor division. Excluding Centex, net new orders decreased moderately compared with 2009.
Southeast:
For 2011, Southeast home sale revenues decreased 10% compared with 2010 due to a 10% decrease in closings as there was no change in the average selling price. The reduction in closing volumes was primarily due to fewer closings in our Georgia division as well as a lower active community count across all divisions. Gross margin improved compared with the prior year period. The increased income before income taxes was also due to lower land-related charges, which totaled $2.4 million in 2011, compared with $14.1 million in 2010. Net new order units decreased 4% in 2011, due in part to decreased activity in our Tennessee division.
For 2010, Southeast home sale revenues increased 34% compared with 2009 due to a 35% increase in closings as there was no change in the average selling price. The increase in closing volumes was largely due to significant increases in our sales volumes in our Coastal Carolinas and Tennessee divisions due to the Centex merger. Excluding Centex, home sale revenues and average selling price increased slightly compared with 2009 and there was no change in closings. The income before income taxes was primarily attributable to higher revenues, increased gross margin, improved overhead leverage compared with 2009, and a decrease in land-related charges to $14.1 million in 2010, from $54.2 million in 2009. New orders increased 20% compared with 2009 largely due to the Centex merger. Excluding Centex, net new orders decreased moderately compared with 2009.
Florida:
For 2011, Florida home sale revenues increased 3% compared with 2010 due to a 1% increase in closings combined with a 2% increase in the average selling price. The majority of this improvement was due to increased closing volumes in North Florida. The income before income taxes in 2011 was attributable to improved gross margins and significantly lower land-related charges than in 2010. Land-related charges were $4.0 million in 2011, compared with $56.8 million in 2010. Net new order units increased by 13% in 2011, in part due to grand openings or grand re-openings at several large communities.
For 2010, Florida home sale revenues increased 22% compared with 2009 due to a 13% increase in closings combined with a 8% increase in the average selling price. The majority of this improvement was due to our South Florida market as our North Florida market experienced a significant reduction in revenues. Excluding Centex, home sale revenues decreased slightly, closings decreased moderately, and average selling price increased slightly compared with 2009. The significant decrease in loss before income taxes in 2010 was attributable to higher revenues and lower land-related charges, which totaled $56.8 million and $250.3 million in 2010 and 2009, respectively. Gross margins increased moderately compared with 2009. Net new orders increased by 11% compared with 2009 primarily due to increased activity in our South Florida market due to the Centex merger. Excluding Centex, net new orders for 2010 decreased moderately from 2009.
Texas:
For 2011, Texas home sale revenues decreased 4% compared with the prior year period due to a 7% decrease in closings partially offset by a 3% increase in the average selling price. The reduction in closing volumes was mainly due to Central Texas and San Antonio. The increased income before income taxes in 2011 was attributable to improved gross margins and lower land-related charges than in the prior year period. Land-related charges were $0.8 million in 2011, compared with $6.8 million in 2010. Net new order units increased by 5% for 2011, in part due to the grand opening of a large community in Houston.
For 2010, Texas home sale revenues increased 34% compared with 2009 due to a 36% increase in closings offset in part by a 2% decrease in the average selling price. Excluding Centex, home sale revenues and closings decreased slightly and average selling price increased slightly compared with 2009. The increased income before income taxes in 2010 was attributable to higher revenues and lower land-related charges, which totaled $6.8 million and $11.0 million in 2010 and 2009, respectively. Gross margins increased moderately compared with 2009. Net new orders increased by 35% compared with 2009, with the largest increases coming from our Houston and Dallas markets due to the Centex merger. Excluding Centex, net new orders for 2010 decreased moderately from 2009.
North:
For 2011, North home sale revenues decreased 16% compared with the prior year period due to a 16% decrease in closings as there was no change in average selling price. The decrease in closing volumes was due to significantly fewer closings in our Minnesota, St. Louis, and Northern California divisions. Gross margin decreased slightly. The loss before income taxes was primarily due to the reduced revenues, offset in part by reduced land-related charges. Land-related charges totaled $14.9 million in 2011, compared with $28.1 million in 2010. Net new order units decreased by 3% in 2011 compared with 2010, primarily in our Minnesota, St. Louis, and Northern California divisions. The sales volumes for our Northern California division reflect the impact of the state homebuyer tax credit that existed in California during 2010. The expiration of this tax credit exacerbated the already challenging local market conditions. These declines were partially offset by improvements in our other North divisions.
For 2010, North home sale revenues increased 13% compared with 2009 due to a 12% increase in closings combined with a 1% increase in the average selling price. The increase in closing volumes was due to increased sales in our Pacific Northwest and St. Louis divisions due to the Centex merger. Excluding Centex, home sale revenues and closings decreased slightly while average selling price increased slightly compared with 2009. In 2010, North recorded land-related charges totaling $28.1 million, compared to land-related charges of $97.3 million in 2009. Gross margins increased moderately compared with 2009. Net new orders increased by 14% compared with 2009 primarily due to increased activity in our Indianapolis, St. Louis, and Minnesota markets, largely due to the Centex merger. Excluding Centex, net new orders for 2010 decreased moderately compared to 2009.
Southwest:
For 2011, Southwest home sale revenues decreased 24% compared with the prior year period due to a 20% decrease in closings and a 6% decrease in average selling price. The decreases were due to weakness in each of our divisions combined with the close-out in late 2010 of our luxury condo community in Hawaii that had average selling prices in excess of $1 million. The increase in income before income taxes was primarily due to improved gross margins and the significant decrease in land-related charges. Land-related charges totaled $3.3 million in 2011, compared with $78.1 million in 2010. The Southwest also benefited from land sale gains totaling $15.5 million in 2011. Net new order units decreased by 9% in 2011 compared with 2010, due to the close-out of our community in Hawaii as well as reduced activity in our Las Vegas and Southern California markets. The sales volumes for our Southern California division reflect the impact of the state homebuyer tax credit that existed in California during 2010. The expiration of this tax credit exacerbated the already challenging local market conditions.
For 2010, Southwest home sale revenues decreased 11% compared with 2009 due to a 16% decrease in closings partially offset by a 6% increase in average selling price. The majority of the decline in volumes was due to our Las Vegas and Arizona markets. Excluding Centex, home sale revenues and closings decreased significantly while average sales price was unchanged compared with 2009. The decreased loss before income taxes in 2010 compared with 2009 was attributable primarily to lower land-related charges of $78.1 million in 2010 compared with $288.0 million in 2009 as well as moderately improved gross margins. Net new orders decreased by 20% in 2010 compared with 2009 primarily due to declines in Las Vegas and Arizona. Excluding Centex, net new orders for 2010 decreased significantly compared to 2009.
Financial Services Operations
We conduct our Financial Services operations, which include mortgage and title operations, through Pulte Mortgage and other subsidiaries. In originating mortgage loans, we initially use our own funds and funds available pursuant to a repurchase agreement with the Company. We subsequently sell such mortgage loans to outside investors. Substantially all of the loans we originate are sold in the secondary market within a short period of time after origination. We sell the servicing rights for the loans we originate on a flow basis through fixed price servicing sales contracts to reduce the risks and costs inherent in servicing loans. This strategy results in owning the servicing rights for only a short period of time. The servicing sales contracts provide for the reimbursement of payments made when loans prepay within specified periods of time, usually 90 to 120 days after sale.
The following table presents selected financial information for our Financial Services operations ($000’s omitted):
Operating as a captive business model primarily targeted to supporting our Homebuilding operations, the operating results of our Financial Services operations are highly correlated to Homebuilding. Since 2007, the mortgage industry has experienced a significant overall tightening of lending standards and a shift toward agency production and fixed rate loans versus adjustable rate mortgages (“ARMs”). Our Homebuilding customers continue to account for substantially all loan production, representing 99% of loan originations for 2011, and 98% of loan originations for both 2010 and 2009.
Revenues
Total Financial Services revenues during 2011 decreased 15% compared to 2010, due in large part to a 12% decrease in loan origination volumes compared to 2010 resulting from lower Homebuilding volumes. Interest income, which is included in mortgage operations revenues, was moderately lower in 2011 than in 2010 due to lower interest rates on loans originated.
Financial Services revenues during 2010 increased 3% compared with 2009, primarily as a result of improved loan pricing in 2010 compared to 2009. Interest income was lower in 2010 than in 2009 due to a combination of lower interest rates and selling loans faster in 2010.
The substantial majority of loan production in 2011, 2010, and 2009 consisted of fixed rate loans, the majority of which are prime, conforming loans. 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. Additionally, the historically low interest rates of the last two years has contributed to profitability by reducing the level of pricing competition in the market. Our capture rate, which represents loan originations from our Homebuilding operations as a percentage of total loan opportunities from our Homebuilding operations, excluding cash closings, decreased in 2011 and 2010 from 2009.
Loan origination liabilities
Our mortgage operations may be responsible for losses associated with mortgage loans originated and sold to investors in the event of errors or omissions relating to representations and warranties that the loans sold meet certain requirements, including representations as to underwriting standards, the existence of primary mortgage insurance, and the validity of certain borrower representations in connection with the loan. If determined to be at fault, we either repurchase the loans from the investors or reimburse the investors' losses (a “make-whole” payment).
Historically, our overall losses relating to this risk were not significant Beginning in 2009, however, we experienced a significant increase in 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. To date, the significant majority of these losses relates to loans originated in 2006 and 2007, during which period inherently riskier loan products became more common in the mortgage origination market. During 2011, 2010, and 2009, we recorded additional provisions for losses as a change in estimate primarily to reflect projected claim volumes in excess of previous estimates. Losses related to loan origination liabilities totaled $59.3 million, $16.9 million, and $60.9 million in 2011, 2010, and 2009, respectively, and are reflected in Financial Services expenses. 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. See our Critical Accounting Policies and Estimates and Note 15 to the Consolidated Financial Statements for additional discussion.
We entered into an agreement in conjunction with the wind down of Centex's mortgage operations, which ceased loan origination activities in December 2009, that provides a guaranty for one major investor of loans originated by Centex. This guaranty provides that we 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 our mortgage subsidiaries, which are included in non-guarantor subsidiaries (see Note 16 for a discussion of non-guarantor subsidiaries).
The mortgage subsidiary of Centex also sold loans to a bank for inclusion in residential mortgage-backed securities (“RMBSs”) issued by the bank. In connection with these sales, Centex's mortgage subsidiary entered into agreements pursuant to which it may be required to indemnify the bank for losses incurred by investors in the RMBSs arising out of material errors or omissions in certain information provided by the mortgage subsidiary relating to the loans and loan origination process. The bank has notified us that it has been named defendant in two lawsuits alleging various violations of federal and state securities laws asserting that untrue statements of material fact were included in the registration statements used to market the sale of two RMBS transactions which included $162 million of loans originated by Centex's mortgage subsidiary. Neither Centex's mortgage subsidiary nor the Company is named as a defendant in these actions. These actions are in their preliminary stage, and we cannot yet quantify Centex's mortgage subsidiary's potential liability as a result of these indemnification obligations. We do not believe, however, that these matters will have a material adverse impact on the results of operations, financial position, or
cash flows of the Company. We are aware of six other RMBS transactions with such indemnity provisions that include an aggregate $116 million of loans, and we are not aware of any current or threatened legal proceedings regarding those transactions.
Income before income taxes
The loss before income taxes in 2011 was due to increased loss reserves related to contingent loan origination liabilities (see Loan origination liabilities above). In addition, loan loss provisions related to our portfolio loans, real estate owned, and mortgage reinsurance reserves totaled $1.7 million and $1.2 million in 2011 and 2010, respectively. Excluding these aggregate losses, our Financial Services segment experienced higher profitability during 2011, primarily as the result of improved loan pricing.
Income before income taxes increased significantly in 2010 compared with 2009 primarily due to lower expenses related to contingent loan origination liabilities (see Loan origination liabilities above). In addition, loan loss provisions related to our portfolio loans, real estate owned, and mortgage reinsurance reserves totaled $1.2 million and $9.8 million in 2010 and 2009, respectively. The 2009 loss before income taxes also included certain integration costs directly related to the Centex merger totaling $8.4 million, which consisted primarily of severance benefits and lease exit and related asset impairment costs.
Income Taxes
Our effective tax rate is 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. Our effective tax rates were a benefit of 32.2%, 11.2%, and 40.1% in 2011, 2010, and 2009, respectively. Due to the effect of our valuation allowance and changes in our unrecognized tax benefits, our effective tax rates for 2009 through 2011 are not correlated to the amount of our pretax loss.
The income tax benefits for 2011 and 2010 were primarily due to the favorable resolution of certain federal and state income tax matters. Our 2009 income tax benefit was primarily due to the impact of the Worker, Homeownership, and Business Assistance Act of 2009 (the “Act”). The Act allowed us to carry back 2009 taxable losses to prior years and receive refunds of previously paid federal income taxes.
Liquidity and Capital Resources
We finance our land acquisition, development, and construction activities and financial services operations by using internally-generated funds and existing credit arrangements. We routinely monitor current and expected operational requirements and financial market conditions to evaluate accessing other available financing sources, including revolving bank credit and 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 December 31, 2011, we had cash and equivalents of $1.1 billion and senior notes of $3.1 billion. We also had restricted cash balances of $101.9 million, the substantial majority of which related to cash serving as collateral under certain letter of credit facilities. Other financing sources include various letter of credit facilities and surety bond arrangements. In recent years, an additional source of liquidity has been refunds of federal income taxes paid in prior years, especially in 2010 as a result of the Worker, Homeownership, and Business Assistance Act of 2009.
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 was 61.4% at December 31, 2011, and 49.5% net of cash and equivalents, including restricted cash. While these debt-to-capital ratios remain above our desired targets, they are not likely to improve significantly until we return to consistent profitability.
Credit agreements
We maintain an unsecured letter of credit facility expiring in June 2014 that permits the issuance of up to $200.0 million of letters of credit. At December 31, 2011, $152.7 million of letters of credit were outstanding under this facility.
On March 25, 2011, we voluntarily terminated our $250.0 million unsecured revolving credit facility (the “Credit Facility”). The termination was effective March 30, 2011. The Credit Facility was scheduled to expire in June 2012, and we did not pay any penalties as a result of the early termination, although we did record a charge of $1.3 million related to unamortized issuance costs. The Credit Facility had no outstanding borrowings and was being used solely to issue letters of credit. We determined it would be more cost effective to enter into separate cash-collateralized letter of credit agreements than to maintain the Credit Facility. The termination of the Credit Facility released $250.0 million of cash that we were required by the Credit Facility to maintain in liquidity reserve accounts.
In connection with the termination of the Credit Facility, we entered into separate cash-collateralized letter of credit agreements with a number of financial institutions. These agreements provide capacity to issue letters of credit totaling up to $191.2 million, the majority of which is uncommitted. Letters of credit totaling $83.2 million were outstanding under these agreements at December 31, 2011. Under these agreements, we are required to maintain deposits with these financial institutions in amounts approximating the letters of credit outstanding. Such deposits are included in restricted cash.
Pulte Mortgage
Pulte Mortgage provides mortgage financing for the majority of our home closings by using its own funds and funds available pursuant to a repurchase agreement with the Company. Pulte Mortgage uses these resources to finance its lending activities until the mortgage loans are sold to third party investors, which generally occurs within 30 days. Given our liquidity position and the cost of third party financing relative to existing mortgage rates, Pulte Mortgage allowed each of its third party borrowing arrangements to expire during 2010 and began funding its operations using Company resources. At December 31, 2011, we funded $127.3 million of Pulte Mortgage's financing needs via the repurchase agreement with the Company.
Stock repurchase programs
Pursuant to the two $100 million stock repurchase programs authorized by our Board of Directors in October 2002 and October 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. We had remaining authorization to purchase common stock aggregating $102.3 million at December 31, 2011.
Dividends
On November 24, 2008, our Board of Directors discontinued the regular quarterly dividend on the Company's common stock effective in the first quarter of 2009. Future dividends will depend upon a variety of factors considered relevant by the Board of Directors, including our earnings, capital requirements, financial condition, market conditions, and other factors.
Cash flows
In the years 2009 and 2010, we generated significant positive cash flow through refunds of income taxes paid in prior year combined with cash acquired in the Centex merger and limiting the level of reinvestment into inventory. We used this positive cash flow to, among other things, maintain significant cash reserves as well as retire outstanding debt. Over the last three years, we have retired $3.2 billion of debt, including debt assumed in the Centex merger (see Note 8 to the Consolidated Financial Statements for additional details regarding these retirements). Additionally, we used $26.6 million and $111.2 million in 2011 and 2010, respectively, to repurchase at a discount prior to their maturity certain community development district obligations in order to improve the future financial performance of the related communities (see Note 15 to the Consolidated Financial Statements) and also voluntarily used Company funds to finance Pulte Mortgage’s lending operations.
We do not anticipate that we will be able to generate positive cash flow in the near future at the same levels as in 2009 and 2010. During 2011, we generated positive operating cash flow. However, should growth conditions return to the homebuilding industry, we may need to invest significant capital into our operations to support such growth.
Operating activities
Our net cash provided by operating activities in 2011 was $17.2 million, compared with net cash provided by operating activities of $590.9 million and $729.4 million in 2010 and 2009, respectively. Generally, the primary drivers of cash flow from operations are profitability and inventory levels. The net losses for 2011, 2010, and 2009 were largely the result of non-cash asset impairments and insurance reserve adjustments, so the cash flows from operations each period primarily relate to changes in working capital. Our positive cash flow from operations in 2011 was primarily the result of a net decrease in inventories combined with income tax refunds, net of payments, of $62.2 million offset by financing Pulte Mortgage's lending operations, which reduced cash flows from operations by $52.8 million in 2011.
Our positive cash flow from operations for 2010 was primarily the result of income tax refunds, net of payments, of $941.3 million. After adjusting for these tax refunds, operating cash flow was negative for 2010. Cash flows from operations in 2010 were negatively impacted by the voluntary repurchase of certain community development district obligations for $111.2 million (see above) and using $74.5 million to finance Pulte Mortgage's lending operations. During 2010, inventory levels and residential mortgage loans available-for-sale decreased slightly. Operating cash flows in 2009 benefited from a significant net decrease in inventory and residential mortgage loans available-for-sale, along with income tax refunds, net of payments, of $357.2 million.
Because we used Company resources to finance Pulte Mortgage's operations during 2011, the majority of cash flows related to Pulte Mortgage are now included in cash flows from operating activities, represented primarily by changes in the balance of residential mortgage loans available-for-sale. Previously, including in 2009, changes in the balance of residential mortgage loans available-for-sale were largely offset by changes in borrowings under Pulte Mortgage's credit arrangements, which were included in cash flows from financing activities.
Investing activities
Net cash used in investing activities was $93.6 million in 2011, compared with net cash used in investing activities of $19.5 million in 2010 and net cash provided by investing activities of $1.7 billion in 2009. The increase from 2010 to 2011 is primarily due to the $83.2 million of restricted cash we are now required to maintain related to our new letter of credit facilities, offset in part by increased proceeds from the sale of fixed assets related to the consolidation of certain facilities and a decrease in contributions to unconsolidated entities. Our contributions to unconsolidated entities and investments in capital expenditures have declined in recent years as the result of the reduction in our overall land investments and consolidations of local operating facilities.
The net cash used in investing activities in 2010 was primarily the result of investments in unconsolidated entities and capital expenditures, partially offset by distributions from unconsolidated entities and a reduction in residential mortgage loans held for investment. Substantially all of the cash provided by investing activities in 2009 was the result of cash acquired in the Centex merger.
Financing activities
Net cash used in financing activities totaled $323.9 million, $948.4 million, and $2.2 billion in 2011, 2010, and 2009, respectively. Cash used in financing activities in 2011 related primarily to the use of $321.1 million to reduce outstanding senior notes, of which $13.9 million was at their scheduled maturity date while the remainder was prior to their scheduled maturity dates.
Net cash used in financing activities in 2010 was primarily the result of the repurchase of senior notes as well as repayments made under Financial Services credit arrangements. As discussed above, we are now using internal funds to finance Pulte Mortgage's operations, the effects of which are reflected in cash flows from operating activities.
The cash used in financing activities in 2009 was largely attributable to $1.9 billion used to retire outstanding debt combined with reductions in amounts outstanding under our Financial Services credit arrangements resulting from the reduction in mortgage loans available-for-sale.
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 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, current industry conditions have resulted in significant pressure on 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, our revenues, gross margins, and net income would be adversely affected.
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 closings. However, the challenging market conditions experienced since early 2006 have lessened the seasonal variations of our results. During 2011, we experienced a return to a somewhat more traditional demand pattern as new orders were higher in the first half of the year and home closings increased in each quarter throughout the year. However, given the current significant uncertainty in the homebuilding industry, we can make no assurances as to when and to what degree our historical seasonality will recur.
Contractual Obligations and Commercial Commitments
The following table summarizes our payments under contractual obligations as of December 31, 2011:
(a)
Represents principal and interest payments related to our senior notes.
(b)
Represents limited recourse collateralized financing arrangements and related interest payments.
(c)
We do not have any payments due in connection with capital lease or long-term purchase obligations.
We are subject to the usual obligations associated with entering into contracts (including land option contracts) for the purchase, development, and sale of real estate in the routine conduct of our business. Option contracts for the purchase of land enable us to defer acquiring portions of properties owned by third parties and unconsolidated entities until we have determined whether to exercise our option, which may serve to reduce our financial risks associated with long-term land holdings. At December 31, 2011, we had $52.5 million of non-refundable deposits and pre-acquisition costs relating to option agreements to acquire 14,077 homesites with a remaining purchase price of $698.0 million. We expect to acquire approximately half of these lots within the next two years and the remainder thereafter.
At December 31, 2011, we had $171.9 million of gross unrecognized tax benefits and $36.9 million of related accrued interest and penalties. We are currently under examination by various taxing jurisdictions and anticipate finalizing the examinations with certain jurisdictions within the next twelve months. However, the final outcome of these examinations is not yet determinable. The statute of limitations for our major tax jurisdictions remains open for examination for tax years 1998-2011.
The following table summarizes our other commercial commitments as of December 31, 2011:
(a)
The $200.0 million in 2014 represents the capacity of our unsecured letter of credit facility, of which $152.7 million was outstanding at December 31, 2011, while the $83.2 million in 2012 represents letters of credit outstanding under our cash-collateralized letter of credit agreements. The above table excludes an aggregate $1.2 billion of surety bonds, which typically do not have stated expiration dates.
Off-Balance Sheet Arrangements
We use letters of credit and surety bonds to guarantee our performance under various contracts, principally in connection with the development of our projects. The expiration dates of the letter of credit contracts coincide with the expected completion date of the related homebuilding projects. If the obligations related to a project are ongoing, annual extensions of the letters of credit are typically granted on a year-to-year basis. At December 31, 2011, we had outstanding letters of credit of $235.9 million. Surety bonds generally do not have stated expiration dates; rather, we are released from the bonds as the contractual performance is completed. These bonds, which approximated $1.2 billion at December 31, 2011, are typically outstanding over a period of approximately three to five years. Because significant construction and development work has been performed related to the applicable projects but has not yet received final acceptance by the respective counterparties, the aggregate amount of surety bonds outstanding is in excess of the projected cost of the remaining work to be performed.
In the ordinary course of business, we enter into land option agreements in order to procure land for the construction of houses in the future. At December 31, 2011, these agreements had an aggregate remaining purchase price of $698.0 million. Pursuant to these land option agreements, we provide a deposit to the seller as consideration for the right to purchase land at different times in the future, usually at predetermined prices. In certain instances, we are required to record the land under option as if we own it. At December 31, 2011, we consolidated certain land option agreements and recorded assets of $24.9 million as land, not owned, under option agreements.
At December 31, 2011, aggregate outstanding debt of unconsolidated joint ventures was $11.1 million, of which our proportionate share of such joint venture debt was $3.2 million. Of our proportionate share of joint venture debt, we provided limited recourse guaranties for $1.2 million at December 31, 2011. See Note 7 to the Consolidated Financial Statements for additional information.
Critical Accounting Policies and Estimates
The accompanying consolidated financial statements were prepared in conformity with United States generally accepted accounting principles. When more than one accounting principle, or the method of its application, is generally accepted, we select the principle or method that is appropriate in our specific circumstances (see Note 1 of our Consolidated Financial Statements). Application of these accounting principles requires us to make estimates about the future resolution of existing uncertainties; as a result, actual results could differ from these estimates. In preparing these consolidated financial statements, we have made our best estimates and judgments of the amounts and disclosures included in the consolidated financial statements, giving due regard to materiality.
Revenue recognition
Homebuilding - Homebuilding revenue and related profit are generally recognized at the time of the closing of the sale, when title to and possession of the property are transferred to the buyer. In situations where the buyer’s financing is originated by Pulte Mortgage, our wholly-owned mortgage subsidiary, and the buyer has not made an adequate initial or continuing investment as required by ASC 360-20, “Property, Plant, and Equipment - Real Estate Sales,” the profit on such sales is deferred until the sale of the related mortgage loan to a third-party investor has been completed, unless there is a loss on the sale in which case the loss on such sale is recognized at the time of closing.
Financial Services - Mortgage servicing fees represent fees earned for servicing loans for various investors. Servicing fees are based on a contractual percentage of the outstanding principal balance, or a contracted set fee in the case of certain sub-servicing arrangements, and are credited to income when related mortgage payments are received or the sub-servicing fees are earned. Loan origination fees, commitment fees, and certain direct loan origination costs are recognized as incurred. Expected
gains and losses from the sale of residential mortgage loans and their related servicing rights are included in the measurement of written loan commitments that are accounted for at fair value through Financial Services revenues at the time of commitment. Subsequent changes in the fair value of these loans are reflected in Financial Services revenues as they occur. Interest income is accrued from the date a mortgage loan is originated until the loan is sold. Loans are placed on non-accrual status once they become greater than 90 days past due their contractual terms. Subsequent payments received are applied according to the contractual terms of the loan.
Inventory valuation
Inventory is stated at the lower of accumulated cost or fair value, as determined in accordance with ASC 360-10, “Property, Plant, and Equipment - Impairment or Disposal of Long-Lived Assets” (“ASC 360-10”). Accumulated cost includes costs associated with land acquisition, land development, and home construction costs, including interest, real estate taxes, and certain direct and indirect overhead costs related to development and construction. For those communities for which construction and development activities have been idled, applicable interest and real estate taxes are expensed as incurred. Land acquisition and development costs are allocated to individual lots using an average lot cost determined based on the total expected land acquisition and development costs and the total expected home closings for the community. The specific identification method is used to accumulate home construction costs.
We capitalize interest cost into homebuilding inventories. 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 home closings.
Cost of revenues includes the construction cost, average lot cost, estimated warranty costs, and commissions and closing costs applicable to the home. The construction cost of the home includes amounts paid through the closing date of the home, plus an appropriate accrual for costs incurred but not yet paid, based on an analysis of budgeted construction costs. This accrual is reviewed for accuracy based on actual payments made after closing compared with the amount accrued, and adjustments are made if needed. Total community land acquisition and development costs are based on an analysis of budgeted costs compared with actual costs incurred to date and estimates to complete. The development cycles for our communities range from under one year to in excess of ten years for certain master planned communities. Adjustments to estimated total land acquisition and development costs for the community affect the amounts costed for the community’s remaining lots.
In accordance with ASC 360-10, we record valuation adjustments on land inventory 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. For communities that demonstrate indicators of impairment, we compare the expected undiscounted cash flows for these communities to their carrying value. For those communities whose carrying values exceed the expected undiscounted cash flows, we calculate the fair value of the community. Impairment charges are required to be recorded if the fair value of the community’s inventory is less than its carrying value.
We generally determine the fair value of each community’s inventory using a combination of discounted cash models and market comparable transactions, where available. These estimated cash flows are significantly impacted by estimates related to expected average selling prices and sale incentives, expected sales paces and cancellation rates, expected land development 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. 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.
Investments in unconsolidated entities
We have investments in a number of unconsolidated entities, including joint ventures, with independent third parties. Many of these unconsolidated entities purchase, develop, and/or sell land and homes in the United States and Puerto Rico. The equity method of accounting is used for unconsolidated entities over which we have significant influence; generally this represents partnership equity or common stock ownership interests of at least 20% and not more than 50%. Under the equity method of accounting, we recognize our proportionate share of the profits and losses of these entities. Certain of these entities sell land to us. In these situations, we defer the recognition of profits from such activities until the time the related homes are sold. The cost method of accounting is used for investments in which we have less than a 20% ownership interest and do not have the ability to exercise significant influence.
We evaluate our investments in unconsolidated entities for recoverability in accordance with ASC 323, “Investments - Equity Method and Joint Ventures”. If we determine that a loss in the value of the investment is other than temporary, we write down the investment to its estimated fair value. Any such losses are recorded to equity in (earnings) loss of
unconsolidated entities. Additionally, each unconsolidated entity evaluates its long-lived assets, such as inventory, for recoverability in accordance with ASC 360-10. Our proportionate share of any such impairments under ASC 360-10 are also recorded to equity in (earnings) loss of unconsolidated entities. Evaluations of recoverability under both ASC 323 and ASC 360-10 are primarily based on projected cash flows supplemented by market comparable transactions, where available. Due to uncertainties in the estimation process and the significant volatility in demand for new housing, actual results could differ significantly from such estimates.
Residential mortgage loans
In accordance with ASC 825, “Financial Instruments” (“ASC 825”), we use the fair value option for our residential mortgage 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. Changes in the fair value of these loans are reflected in revenues as they occur.
Loans held for investment consist of a portfolio of loans that either have been repurchased from investors or were not saleable upon closing. These loans are carried at cost and are reviewed for impairment when recoverability becomes doubtful.
Loan origination liabilities
Our mortgage operations may be responsible for losses associated with mortgage loans originated and sold to investors in the event of errors or omissions relating to representations and warranties that the loans sold meet certain requirements, including representations as to underwriting standards, the existence of primary mortgage insurance, and the validity of certain borrower representations in connection with the loan. If determined to be at fault, we either repurchase the loans from the investors or reimburse the investors' losses (a “make-whole” payment).
We sell a substantial majority of the loans we originate to investors each month, retaining limited risk related to such loans. Historically, our overall losses relating to this risk were not significant. Beginning in 2009, however, we experienced a significant increase in 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. To date, the significant majority of these losses relates to loans originated in 2006 and 2007, during which period inherently riskier loan products became more common in the mortgage origination market. In 2006 and 2007, we originated $39.5 billion of loans, excluding loans originated by Centex's former subprime loan business sold by Centex in 2006. Because we generally do not retain the servicing rights to the loans we originate, information regarding the current and historical performance, credit quality, and outstanding balances of such loans is limited. Estimating these loan origination liabilities is further complicated by uncertainties surrounding numerous external factors, such as various macroeconomic factors (including unemployment rates and changes in home prices), actions taken by third parties, including the parties servicing the loans, and the U.S. federal government in its dual capacity as regulator of the U.S. mortgage industry and conservator of the government-sponsored enterprises commonly known as Fannie Mae and Freddie Mac, which own or guarantee the majority of mortgage loans in the U.S.
Most requests received to date relate to make-whole payments on loans that have been foreclosed, generally after a portion of the loan principal had been paid down, which reduces our exposure. Requests not immediately refuted by us undergo extensive analysis to confirm the exposure, attempt to cure the identified defect, and, when necessary, determine our liability. We establish liabilities for such anticipated losses based upon, among other things, the level of current unresolved repurchase requests, the volume of estimated probable future repurchase requests, our ability to cure the defects identified in the repurchase requests, and the severity of the estimated loss upon repurchase. Determining these estimates and the resulting liability requires a significant level of management judgment. We are generally able to cure or refute over 60% of the requests received from investors such that repurchases or make-whole payments are not required. For those requests requiring repurchases or make-whole payments, actual loss severities generally approximate 50% of the outstanding principal balance.
Our current estimates assume that claim volumes will not decline to pre-2009 levels until after 2013, an extension of two years beyond our previous estimates as of December 31, 2010. 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. For example, if the total number of loans we are required to repurchase is ultimately 10% lower or higher than our current estimates, the amount of future losses would decrease or increase by approximately $13.0 million.
Intangible assets
We have recorded intangible assets related to tradenames acquired with the Centex merger completed in 2009 and the Del Webb merger completed in 2001, which are being amortized over their estimated useful lives. The carrying values and ultimate realization of these assets are dependent upon estimates of future earnings and benefits that we expect to generate from their use. If we determine that the carrying values of intangible assets may not be recoverable based upon the existence of one or more indicators of impairment, we use a projected undiscounted cash flow method to determine if impairment exists. If the carrying values of the intangible assets exceed the expected undiscounted cash flows, then we measure impairment as the difference between the fair value of the asset and the recorded carrying value. While the industry downturn in recent years has resulted in a decline in the fair value of these intangible assets, this decline has not yet resulted in an impairment of the assets' carrying values. However, if our expectations of future results and cash flows decrease significantly or if our strategy related to the use of the intangible assets changes, the related intangible assets may be impaired.
Allowance for warranties
Home purchasers are provided with a limited warranty against certain building defects, including a one-year comprehensive limited warranty and coverage for certain other aspects of the home’s construction and operating systems for periods of up to ten years. We estimate the costs to be incurred under these warranties and record a liability in the amount of such costs at the time product revenue is recognized. Factors that affect our warranty liability include the number of homes sold, historical and anticipated rates of warranty claims, and the cost per claim. We periodically assess the adequacy of our recorded warranty liability for each geographic market in which we operate and adjust the amounts as necessary. Actual warranty costs in the future could differ from our estimates.
Self-insured risks
We maintain, and require our subcontractors to maintain, general liability insurance coverage. We also maintain builders' risk, property, errors and omissions, workers compensation, and other business insurance coverage. These insurance policies protect us against a portion of the risk of loss from claims. However, we retain a significant portion of the overall risk for such claims either through policies issued by our captive insurance subsidiaries or through our own self-insured per occurrence and aggregate retentions, deductibles, and claims in excess of available insurance policy limits.
Our general liability insurance includes coverage for certain construction defects. While construction defect claims can relate to a variety of circumstances, the majority of our claims relate to alleged problems with siding, plumbing, foundations and other concrete work, windows, roofing, and heating, ventilation and air conditioning systems. The availability of general liability insurance for the homebuilding industry and its subcontractors has become increasingly limited, and the insurance policies available require companies to maintain higher per occurrence and aggregate retention levels. In certain instances, we may offer our subcontractors the opportunity to purchase insurance through one of our captive insurance subsidiaries or to participate in a project-specific insurance program provided by the Company. Policies issued by the captive insurance subsidiaries represent self-insurance of these risks by the Company. This self-insured exposure is limited by reinsurance policies that we purchase. General liability coverage for the homebuilding industry is complex, and our coverage varies from policy year to policy year. We are self-insured for a per occurrence deductible, which is capped at an overall aggregate retention level. Beginning with the first dollar, amounts paid on insured claims satisfy our per occurrence and aggregate retention obligations. Any amounts incurred in excess of the occurrence or aggregate retention levels are covered by insurance up to our purchased coverage levels. Our insurance policies, including the captive insurance subsidiaries' reinsurance policies, are maintained with highly-rated underwriters for whom we believe counterparty default risk is not significant.
At any point in time, we are managing over 1,000 individual claims related to general liability, property, errors and omission, workers compensation, and other business insurance coverage. We reserve for costs associated with such claims (including expected claims management expenses relating to legal fees, expert fees, and claims handling expenses) on an undiscounted basis at the time product revenue is recognized for each home closing and evaluate the recorded liabilities based on actuarial analyses of our historical claims. The actuarial analyses calculate an estimate of the ultimate net cost of all unpaid losses, including estimates for incurred but not reported losses ("IBNR"). IBNR represents losses related to claims incurred but not yet reported plus development on reported claims. These estimates make up a significant portion of our liability 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 construction defect claims are reported and resolved over an extended period often exceeding ten years. In certain instances, we have 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.
The recorded reserves include loss estimates related to both (i) existing claims and related claim expenses and (ii) IBNR and related claim expenses. Liabilities related to IBNR and related claim expenses represented approximately 78% of the total general liability reserves, which represent the vast majority of the total recorded reserves, at both December 31, 2011 and 2010. The actuarial analyses that determine the IBNR portion of reserves consider a variety of factors, including the frequency and severity of losses, which are based on our historical claims experience supplemented by industry data. The actuarial analyses of the reserves also consider historical third party recovery rates and claims management expenses.
Adjustments to estimated reserves are recorded in the period in which the change in estimate occurs. Because the majority of our recorded reserves relates to IBNR, adjustments to reserve amounts for individual existing claims generally do not impact the recorded reserves materially. However, changes in the frequency and timing of reported claims and the estimates of specific claim values can impact the underlying inputs and trends utilized in the actuarial analyses, which could have a material impact on the recorded reserves.
We have experienced a high level of insurance-related expenses in recent years, primarily due to the adverse development of general liability claims, the frequency and severity of which have increased significantly over historical levels. During 2010, we experienced a greater than anticipated frequency of newly reported claims and a significant increase in specific case reserves related to certain known claims. The general nature of these claims was not out of the ordinary, but the frequency and severity of the claims were in excess of our historical experience. As a result of these unfavorable trends, we recorded additional reserves totaling $280.4 million ($0.74 per basic and diluted share) within selling, general, and administrative expenses. Substantially all of this additional reserve related to general liability exposures, a large portion of which resulted from revising our actuarial assumptions surrounding the long-term frequency, severity, and development of claims. During the industry downturn over the last several years, and especially in 2010, we experienced adverse claim frequency and severity compared with longer term averages. In 2010, we deemed it appropriate to assume that the long-term future frequency, severity, and development of claims will most closely resemble the claims activity experienced in recent years.
Our recorded reserves for all such claims totaled $741.4 million and $785.6 million at December 31, 2011 and 2010, respectively, the vast majority of which relate to general liability claims. Because of the inherent uncertainty in estimating future losses related to these claims, actual costs could differ significantly from estimated costs. Based on the actuarial analyses performed, we believe the range of reasonably possible losses related to these claims is $650 million to $850 million. While this range represents our best estimate of our ultimate liability related to these claims, due to a variety of factors, including those factors described above, there can be no assurance that the ultimate costs realized by us will fall within this range.
Income taxes
We calculate our provision for income taxes using the asset and liability method, under which deferred tax assets and liabilities are recognized by identifying the temporary differences arising from the different treatment of items for tax and accounting purposes. In assessing the realizability of deferred tax assets, we consider whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. Our assessment considers, among other matters, the nature, frequency, and magnitude of current and cumulative income and losses, forecasts of future profitability, the duration of statutory carryback or carryforward periods, our experience with operating loss and tax credit carryforwards being used before expiration, and tax planning alternatives. The ultimate realization of deferred tax assets is primarily dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. In determining the future tax consequences of events that have been recognized in our financial statements or tax returns, judgment is required. Differences between the anticipated and actual outcomes of these future tax consequences could have a material impact on our consolidated results of operations or financial position.
We follow the provisions of ASC 740, “Income Taxes” (“ASC 740”), which prescribes a minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. ASC 740 also provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, and disclosure. Significant judgment is required to evaluate uncertain tax positions. Evaluations of our tax positions consider changes in facts or circumstances, changes in law, correspondence with taxing authorities, and settlements of audit issues.
New accounting pronouncements
See Note 1 to the Consolidated Financial Statements.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are subject to interest rate risk on our rate-sensitive financings to the extent long-term rates decline. The following tables set forth, as of December 31, 2011 and 2010, our rate-sensitive financing obligations, principal cash flows by scheduled maturity, weighted-average interest rates, and estimated fair value ($000’s omitted).
Derivative instruments and hedging activities
Pulte Mortgage is exposed to market risks from commitments to lend, movements in interest rates, and canceled 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). The interest rate risk continues through the loan closing and until the loan is sold to an investor. During 2011, this period of interest rate exposure averaged approximately 60 days. In periods of rising interest rates, the length of exposure will generally increase due to customers locking in an interest rate sooner as opposed to letting the interest rate float.
In order to reduce these risks, we use other derivative financial instruments to economically hedge the interest rate lock commitment, principally cash forward placement contracts on mortgage-backed securities and whole loan investor commitments. We enter into one of the aforementioned derivative financial instruments upon accepting interest rate lock commitments. Changes in the fair value of interest rate lock commitments and the other derivative financial instruments are recognized in Financial Services revenues. We do not use any derivative financial instruments for trading purposes.
Hypothetical changes in the fair values of our financial instruments arising from immediate parallel shifts in long-term mortgage rates of 50, 100, and 150 basis points would not be material to our financial results.
SPECIAL NOTES CONCERNING FORWARD-LOOKING STATEMENTS
As a cautionary note, except for the historical information contained herein, certain matters discussed in Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, and Item 7a, 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 the debt and equity markets; competition within the industries in which PulteGroup operates; the availability and cost of land and other raw materials used by PulteGroup in its homebuilding operations; the impact of any changes to our strategy in responding to continuing adverse conditions in the industry, including any changes regarding our land positions; 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 Item 1A - Risk Factors 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.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
PULTEGROUP, INC.
CONSOLIDATED BALANCE SHEETS
December 31, 2011 and 2010
($000’s omitted, except per share data)
See Notes to Consolidated Financial Statements.
PULTEGROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
For the years ended December 31, 2011, 2010, and 2009
(000’s omitted, except per share data)
See Notes to Consolidated Financial Statements.
PULTEGROUP, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
AND COMPREHENSIVE INCOME (LOSS)
For the years ended December 31, 2011, 2010, and 2009
(000’s omitted, except per share data)
See Notes to Consolidated Financial Statements.
PULTEGROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the years ended December 31, 2011, 2010, and 2009
($000’s omitted)
See Notes to Consolidated Financial Statements.
PULTEGROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of significant accounting policies
Basis of presentation
PulteGroup, Inc. is one of the largest homebuilders in the United States, and our common stock trades on the New York Stock Exchange under the ticker symbol “PHM”. Unless the context otherwise requires, the terms "PulteGroup", the "Company", "we", "us", and "our" used herein refer to PulteGroup, Inc. and its subsidiaries. While our subsidiaries engage primarily in the homebuilding business, we also have mortgage banking operations, conducted principally through Pulte Mortgage LLC (“Pulte Mortgage”), and title operations.
On August 18, 2009, we completed the acquisition of Centex Corporation (“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.
The consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles and include the accounts of PulteGroup, Inc. and all of its direct and indirect subsidiaries and variable interest entities in which PulteGroup, Inc. is deemed to be the primary beneficiary. All significant intercompany accounts, transactions, and balances have been eliminated in consolidation.
Use of estimates
The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.
Reclassification
Certain prior period amounts have been reclassified to conform to the current year presentation, including the reclassification to cash and equivalents of certain deposits in-transit previously classified separately as unfunded settlements (see Cash and equivalents below), the reclassification of certain accrued liabilities to self-insured liabilities (see Note 15), and a reclassification of our segment information (see Note 6).
Subsequent events
We evaluated subsequent events up until the time the financial statements were filed with the Securities and Exchange Commission ("SEC").
Cash and equivalents
Cash and equivalents include institutional money market investments and time deposits with a maturity of three months or less when acquired. Cash and equivalents at December 31, 2011 and 2010 also included $13.0 million and $12.8 million, respectively, of cash from home closings held in escrow for our benefit, typically for less than five days, which are considered deposits in-transit.
Restricted cash
We maintain certain cash balances that are restricted as to their use. Restricted cash consists primarily of deposits maintained with financial institutions under certain cash-collateralized letter of credit agreements (see Note 8). The remaining balances relate to certain other accounts with restrictions, including customer deposits on home sales that are temporarily restricted by regulatory requirements until title transfers to the homebuyer.
Investments in unconsolidated entities
We have investments in a number of unconsolidated entities, including joint ventures, with independent third parties. Many of these unconsolidated entities purchase, develop, and/or sell land and homes in the U.S. and Puerto Rico. The equity method of accounting is used for unconsolidated entities over which we have significant influence; generally this
PULTEGROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
represents ownership interests of at least 20% and not more than 50%. Under the equity method of accounting, we recognize our proportionate share of the profits and losses of these entities. Certain of these entities sell land to us. In these situations, we defer the recognition of profits from such activities until the time the related homes are sold. The cost method of accounting is used for investments in which we have less than a 20% ownership interest and do not have the ability to exercise significant influence.
We evaluate our investments in unconsolidated entities for recoverability in accordance with Accounting Standards Codification (“ASC”) 323, “Investments - Equity Method and Joint Ventures” (“ASC 323”). If we determine that a loss in the value of the investment is other than temporary, we write down the investment to its estimated fair value. Any such losses are recorded to equity in (earnings) loss of unconsolidated entities in the Consolidated Statements of Operations. Additionally, each unconsolidated entity evaluates its long-lived assets, such as inventory, for recoverability in accordance with ASC 360-10, “Property, Plant, and Equipment - Impairment or Disposal of Long-Lived Assets” (“ASC 360-10”). Our proportionate share of any such impairments is also recorded to equity in (earnings) loss of unconsolidated entities in the Consolidated Statements of Operations. Evaluations of recoverability under both ASC 323 and ASC 360-10 are primarily based on projected cash flows. Due to uncertainties in the estimation process and the significant volatility in demand for new housing, actual results could differ significantly from such estimates. See Note 7.
Notes receivable
In certain instances, we may accept consideration for land sales or other transactions in the form of a note receivable. The counterparties for these transactions are generally land developers or other real estate investors. We consider the creditworthiness of the counterparty when evaluating the relative risk and return involved in pursuing the applicable transaction. Due to the unique facts and circumstances surrounding each receivable, we actively monitor each individual receivable and assess the need for an allowance for each receivable on an individual basis. Factors considered as part of this assessment include the counterparty's payment history, the value of any underlying collateral, communications with the counterparty, knowledge of the counterparty's financial condition and plans, and the current and expected economic environment. Allowances are recorded in other expense (income), net when it becomes likely that some amount will not be collectible. Such receivables are reported net of allowance for credit losses within other assets. Notes receivable are written off when it is determined that collection efforts will no longer be pursued. Interest income is recognized as earned.
The following represents our notes receivable and related allowance for credit losses at December 31, 2011 and 2010 ($000’s omitted):
The increase in the allowance for credit losses during 2011 relates primarily to the recording of additional reserves. We also record other receivables from various parties in the normal course of business, including amounts due from municipalities, insurance companies, and vendors. Such receivables are generally non-interest bearing and non-collateralized, payable either on demand or upon the occurrence of a specified event, and are generally reported in other assets. See Residential mortgage loans available-for-sale in Note 1 for a discussion of our receivables related to mortgage operations.
Intangible assets
Intangible assets consist of trademarks and tradenames acquired in connection with the 2009 acquisition of Centex and the 2001 acquisition of Del Webb. These intangible assets were valued at the acquisition date utilizing proven valuation procedures and are being amortized over 20-year lives. The acquired cost and accumulated amortization of our intangible assets were $259.0 million and $96.7 million, respectively, at December 31, 2011, and $259.0 million and $83.6 million, respectively, at December 31, 2010. Amortization expense totaled $13.1 million in 2011, $13.1 million in 2010, and $14.0 million in 2009 (including $4.0 million related to the fair value of customer backlog acquired with the Centex merger that was fully amortized as of December 31, 2009). Amortization expense for trademarks and tradenames is expected to be $13.1 million in each of the next five years.
PULTEGROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
The ultimate realization of these assets is dependent upon estimates of future earnings and benefits that we expect to generate from their use. If we determine that the carrying values of intangible assets may not be recoverable based upon the existence of one or more indicators of impairment, we use a projected undiscounted cash flow method to determine if impairment exists. If the carrying values of the intangible assets exceed the expected undiscounted cash flows, then we measure impairment as the difference between the fair value of the asset and the recorded carrying value. If our expectations of future results and cash flows decrease significantly or if our strategy related to the use of such intangible assets changes, the related intangible assets may be impaired. There were no impairments of intangible assets during 2011, 2010, or 2009.
Goodwill
Goodwill, which represents the cost of acquired companies in excess of the fair value of the net assets of such companies at the acquisition date, had been recorded in connection with various acquisitions. All goodwill was written-off as of December 31, 2011. Recorded goodwill was allocated to our reporting units based on the relative fair value of each acquired reporting unit. In accordance with ASC 350, “Intangibles-Goodwill and Other”, we assessed the goodwill balance of each reporting unit for impairment annually in the fourth quarter and when events or changes in circumstances indicated the carrying amount might not be recoverable. See Note 3.
Fixed assets and depreciation
Fixed assets are recorded at cost. Maintenance and repair costs are expensed as incurred. Depreciation is computed by the straight-line method based upon estimated useful lives as follows: vehicles, three to seven years, model and office furniture, two to three years, and equipment, three to ten years. Fixed assets are included in other assets and totaled $53.2 million net of accumulated depreciation of $203.4 million at December 31, 2011 and $59.3 million net of accumulated depreciation of $237.0 million at December 31, 2010. Depreciation expense totaled $19.0 million, $32.5 million, and $40.2 million in 2011, 2010, and 2009, respectively.
Advertising costs
Advertising costs are expensed as incurred and totaled $55.1 million, $54.9 million, and $47.1 million, in 2011, 2010, and 2009, respectively.
Employee benefits
We maintain defined contribution retirement plans that cover substantially all of our employees. Company contributions to these plans were suspended during 2009 but have been reestablished effective in 2012. Company contributions pursuant to the plans totaled $0.2 million and $5.7 million in 2010 and 2009, respectively. There were no Company contributions during 2011.
Other expense (income), net
Other expense (income), net consists of the following ($000’s omitted):
(a)
Excludes lease exit costs classified within Financial Services expenses of $0.1 million, $2.9 million, and $0.7 million in 2011, 2010, and 2009, respectively. See Note 4.
PULTEGROUP, INC.
NOTES TO 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 stock options, restricted stock units, and non-vested shares of restricted stock. Any stock 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. Due to the net loss recorded during the periods, all stock options and non-vested restricted stock and restricted stock units were excluded from the calculation for 2011, 2010, and 2009.
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 our outstanding restricted stock and restricted stock units are considered participating securities, there were no earnings attributable to restricted shareholders during 2011, 2010, or 2009.
Stock-based compensation
We measure compensation cost for our stock options at fair value on the date of grant and recognize compensation expense on the graded vesting method over the vesting period. The graded vesting method provides for vesting of portions of the overall awards at interim dates and results in greater expense in earlier years than the straight-line method. The fair value of our stock options is determined using primarily the Black-Scholes valuation model. The fair value of restricted stock is determined based on the number of shares granted and the quoted price of our common stock. We recognize compensation expense for restricted stock grants, the majority of which cliff vest at the end of three years, ratably over the vesting period. Compensation expense related to our share-based awards is included in selling, general, and administrative expense, except for a small portion recognized in Financial Services expenses. See Note 10.
Income taxes
The provision for income taxes is calculated using the asset and liability method, under which deferred tax assets and liabilities are recognized by identifying the temporary differences arising from the different treatment of items for tax and accounting purposes. In assessing the realizability of deferred tax assets, we consider whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is primarily dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. In determining the future tax consequences of events that have been recognized in the financial statements or tax returns, judgment is required. Differences between the anticipated and actual outcomes of these future tax consequences could have a material impact on the consolidated results of operations or financial position.
We follow the provisions of ASC 740, “Income Taxes” (“ASC 740”), which prescribes a minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. Significant judgment is required to evaluate uncertain tax positions. Our evaluations of tax positions consider a variety of factors, including changes in facts or circumstances, changes in law, correspondence with taxing authorities, and effective settlements of audit issues. Changes in the recognition or measurement of uncertain tax positions could result in material increases or decreases in income tax expense in the period in which the change is made. Interest and penalties related to unrecognized tax benefits are recognized in the consolidated financial statements as a component of income tax expense. See Note 11.
Homebuilding revenue recognition
Homebuilding revenue and related profit are generally recognized at the closing of the sale, when title to and possession of the property are transferred to the buyer. In situations where the buyer’s financing is originated by Pulte Mortgage and the buyer has not made an adequate initial or continuing investment as required by ASC 360-20, “Property, Plant, and Equipment - Real Estate Sales” (“ASC 360-20”), the profit on such sale is deferred until the sale of the related mortgage loan to a third-party investor has been completed, unless there is a loss on the sale in which case the loss on such sale is recognized at the time of closing. Such amounts were not material at either December 31, 2011 or December 31, 2010.
PULTEGROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Sales incentives
When sales incentives involve a discount on the selling price of the home, we record the discount as a reduction of revenue at the time of house closing. If the sales incentive requires us to provide a free product or service to the customer, the cost of the free product or service is recorded as cost of revenues at the time of house closing. This includes the cost related to optional upgrades and seller-paid financing or closing costs. Sales incentives in the form of seller-paid homeowners’ association fees or merchandise are also recorded to cost of revenues.
Inventory
Inventory is stated at the lower of accumulated cost or fair value, as determined in accordance with ASC 360-10. Accumulated cost includes costs associated with land acquisition, land development, and home construction costs, including interest, real estate taxes, and certain direct and indirect overhead costs related to development and construction. For those communities for which construction and development activities have been idled, applicable interest and real estate taxes are expensed as incurred. Land acquisition and development costs are allocated to individual lots using an average lot cost determined based on the total expected land acquisition and development costs and the total expected home closings for the community. The specific identification method is used to accumulate home construction costs.
Cost of revenues includes the construction cost, average lot cost, estimated warranty costs, and commissions and closing costs applicable to the home. The construction cost of the home includes amounts paid through the closing date of the home, plus an appropriate accrual for costs incurred but not yet paid, based on an analysis of budgeted construction costs. This accrual is reviewed for accuracy based on actual payments made after closing compared with the amount accrued, and adjustments are made if needed. Total community land acquisition and development costs are based on an analysis of budgeted costs compared with actual costs incurred to date and estimates to complete. The development cycles for our communities range from under one year to in excess of ten years for certain master planned communities. Adjustments to estimated total land acquisition and development costs for the community affect the amounts costed for the community’s remaining lots. See Note 5.
Land, not owned, under option agreements
In the ordinary course of business, we enter into land option agreements in order to procure land for the construction of homes in the future. Pursuant to these land option agreements, we generally provide a deposit to the seller as consideration for the right to purchase land at different times in the future, usually at predetermined prices. Under ASC 810, “Consolidation” (“ASC 810”), if the entity holding the land under option is a variable interest entity (“VIE”), our deposit represents a variable interest in that entity. If we are determined to be the primary beneficiary of the VIE, then we are required to consolidate the VIE.
The VIE is generally protected from the first dollar of loss under our land option agreement due to our deposit. Likewise, the VIE's gains are generally capped based on the purchase price within the land option agreement. However, we generally have little control or influence over the operations of these VIEs due to our lack of an equity interest in them. Additionally, creditors of the VIE have no recourse against us, and we do not provide financial or other support to these VIEs other than as stipulated in the land option agreements. Our maximum exposure to loss related to these VIEs is generally limited to our deposits and pre-acquisition costs under the applicable land option agreements. In recent years, we have canceled a significant number of land option agreements, which has resulted in significant write-offs of the related deposits and pre-acquisition costs but did not expose us to the overall risks or losses of the applicable VIEs. No VIEs required consolidation under ASC 810 at either December 31, 2011 or December 31, 2010.
Additionally, we determined that certain land option agreements represent financing arrangements pursuant to ASC 470-40, “Accounting for Product Financing Arrangements” (“ASC 470-40”), even though we generally have no obligation to pay these future amounts. As a result, we recorded $24.9 million and $50.8 million at December 31, 2011 and December 31, 2010, 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, some of which are with VIEs, in the event we exercise the purchase rights under the agreements.
PULTEGROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
The following provides a summary of our interests in land option agreements as of December 31, 2011 and December 31, 2010 ($000’s omitted):
Land held for sale
Land held for sale is recorded at the lower of cost or fair value less costs to sell. See Note 5.
Start-up costs
Costs and expenses associated with entry into new homebuilding markets and opening new communities in existing markets are expensed when incurred.
Allowance for warranties
Home purchasers are provided with a limited warranty against certain building defects. We estimate the costs to be incurred under these warranties and record a liability in the amount of such costs at the time the product revenue is recognized.
Self-insured risks
We maintain, and require the majority of our subcontractors to maintain, general liability insurance coverage, including coverage for certain construction defects. We also maintain property, errors and omissions, workers compensation, and other business insurance coverage. These insurance policies protect us against a portion of the risk of loss from claims, subject to certain self-insured per occurrence and aggregate retentions, deductibles, and available policy limits. However, we retain a significant portion of the overall risk for such claims. We reserve for these costs on an undiscounted basis at the time product revenue is recognized for each home closing and evaluate the recorded liabilities based on actuarial analyses of our historical claims, which include estimates of claims incurred but not yet reported. Adjustments to estimated reserves are recorded in the period in which the change in estimate occurs. In certain instances, we have the ability to recover a portion of our costs under various insurance policies or from its subcontractors or other third parties. Estimates of such amounts are recorded when recovery is considered probable. See Note 15.
Residential mortgage loans available-for-sale
Substantially all of the loans originated by us are sold in the secondary mortgage market within a short period of time after origination. In accordance with ASC 825, “Financial Instruments” (“ASC 825”), we use the fair value option for residential mortgage loans available-for-sale. Election of the fair value option for these loans 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. We do not designate any derivative instruments as hedges or apply the hedge accounting provisions of ASC 815, “Derivatives and Hedging.” Fair values for agency residential mortgage loans available-for-sale are determined based on quoted market prices for comparable instruments. Fair values for 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. See Note 15 for discussion of the risks retained related to mortgage loan originations.
PULTEGROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Expected gains and losses from the sale of residential mortgage loans and their related servicing rights are included in the measurement of written loan commitments that are accounted for at fair value through Financial Services revenues at the time of commitment. Subsequent changes in the fair value of these loans are reflected in Financial Services revenues as they occur. At December 31, 2011 and 2010, residential mortgage loans available-for-sale had an aggregate fair value of $258.1 million and $176.2 million, respectively, and an aggregate outstanding principal balance of $248.2 million and $175.9 million, respectively. The net gain (loss) resulting from changes in fair value of these loans totaled $(0.4) million and $1.9 million for the years ended December 31, 2011 and 2010, respectively. 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 during 2011, 2010, and 2009 were $59.1 million, $66.0 million, and $59.5 million, respectively.
Mortgage servicing rights
We sell the servicing rights for the loans we originate on a flow basis through fixed price servicing sales contracts to reduce the risks and costs inherent in servicing loans. This strategy results in owning the servicing rights for only a short period of time. We recognize the fair value of our 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, we do 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. We establish reserves for this liability at the time the sale is recorded. Such reserves were immaterial at December 31, 2011 and 2010 and are included in accrued and other liabilities. During 2011, 2010, and 2009, servicing rights recognized in Financial Services revenues totaled $16.0 million, $20.8 million, and $29.3 million, respectively.
Loans held for investment
We originate interim financing mortgage loans for certain customers and also have a portfolio of loans that either have been repurchased from investors or were not saleable upon closing. These loans are carried at cost and are reviewed for impairment when recoverability becomes doubtful. Loans held for investment are included in other assets and totaled $2.4 million and $3.1 million (net of reserves of $1.9 million and $3.1 million) at December 31, 2011 and 2010, respectively.
Interest income on mortgage loans
Interest income is recorded in Financial Services revenues, accrued from the date a mortgage loan is originated until the loan is sold, and totaled $5.0 million, $5.8 million, and $7.7 million in 2011, 2010, and 2009, respectively. Loans are placed on non-accrual status once they become greater than 90 days past due their contractual terms. Subsequent payments received are applied according to the contractual terms of the loan. Mortgage discounts are not amortized as interest income due to the short period the loans are held until sale to third party investors. The fair value of mortgage loans held for sale at December 31, 2011 and 2010 reflects unamortized discounts of $0.7 million and $1.0 million, respectively.
Mortgage servicing, origination, and commitment fees
Mortgage servicing fees represent fees earned for servicing loans for various investors. Servicing fees are based on a contractual percentage of the outstanding principal balance, or a contracted set fee in the case of certain sub-servicing arrangements, and are credited to income when related mortgage payments are received or the sub-servicing fees are earned. Loan origination costs related to residential mortgage loans available-for-sale are recognized as incurred in Financial Services expenses while the associated mortgage origination fees are recognized in Financial Services revenues as earned, generally upon loan closing.
Title services
Revenues associated with our title operations are recognized within Financial Services revenues as closing services are rendered and title insurance policies are issued, both of which generally occur as each home is closed. We have only limited risk associated with our title operations due to the low incidence of claims related to underwriting risk associated with issued title insurance policies and fiduciary risk resulting from closing services.
PULTEGROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Derivative instruments and hedging activities
We are exposed to market risks from commitments to lend, movements in interest rates, and canceled 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, principally cash forward placement contracts on mortgage-backed securities and whole loan investor commitments. We do not use any derivative financial instruments for trading purposes. We enter into one of the aforementioned derivative financial instruments upon accepting interest rate lock commitments. Changes in the fair value of interest rate lock commitments and other derivative financial instruments are recognized in Financial Services revenues and the fair values are reflected in other assets or other liabilities, as applicable.
Fair values for interest rate lock commitments, including the value of servicing rights, are based on market prices for similar instruments. At December 31, 2011 and 2010, we had interest rate lock commitments in the total amount of $97.6 million and $99.0 million, respectively, which were originated at interest rates prevailing at the date of commitment. Since we 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. We evaluate the creditworthiness of these transactions through our normal credit policies.
Forward 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. Forward contracts on mortgage-backed securities are the predominant derivative financial instruments used to minimize the market risk during the period from the time we extend an interest rate lock to a loan applicant until the time the loan is sold to an investor. Forward contracts on mortgage-backed securities are valued based on market prices for similar instruments. Fair values for whole loan investor commitments are based on market prices for similar instruments from the specific whole loan investor. At December 31, 2011, we had unexpired forward contracts and whole loan investor commitments of $311.5 million and $1.6 million, respectively, compared with cash forward contracts on mortgage-backed securities and whole loan investor commitments of $198.0 million and $59.0 million, respectively, at December 31, 2010.
There are no credit-risk-related contingent features within our derivative agreements, and counterparty risk is considered minimal. Gains and losses on interest rate lock commitments are substantially offset by corresponding gains or losses on forward contracts on mortgage-backed securities and whole loan investor commitments. At December 31, 2011, the maximum length of time that we were exposed to the variability in future cash flows of derivative instruments was approximately 60 days.
The fair value of derivative instruments and their location in the Consolidated Balance Sheet is summarized below ($000’s omitted):
New accounting pronouncements
In May 2011, the FASB issued Accounting Standards Update No. 2011-04, “Fair Value Measurement” (“ASU 2011-04”), which amends Accounting Standards Codification (ASC) 820 to clarify existing guidance and minimize differences between U.S. GAAP and International Financial Reporting Standards (IFRS). ASU 2011-04 requires entities to provide information about valuation techniques and unobservable inputs used in Level 3 fair value measurements and provide a narrative description of the sensitivity of Level 3 measurements to changes in unobservable inputs. ASU 2011-04 will be effective for our fiscal year beginning January 1, 2012 and is not expected to have a material impact on our financial statements.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
In June 2011, the FASB issued Accounting Standards Update No. 2011-05, “Statement of Comprehensive Income” (“ASU 2011-05”), which requires entities to present net income and other comprehensive income in either a single continuous statement or in two separate, but consecutive, statements of net income and other comprehensive income. ASU 2011-05 will not impact our reported results of operations but will impact our financial statement presentation as we currently present items of other comprehensive income in the statement of shareholders' equity. ASU 2011-05 will be effective for our fiscal year beginning January 1, 2012.
2. Centex merger
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 the consolidated financial statements from the date of the merger.
We 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.
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 us at their estimated fair values, with certain limited exceptions. We 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.
The following table summarizes the total consideration transferred and the final amounts recognized as of the merger date (000’s omitted):
PULTEGROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Of the $100.0 million of acquired intangible assets, $96.0 million related to tradenames that are being amortized over 20 years. The remaining $4.0 million of acquired intangible assets related to acquired backlog at August 18, 2009 that was amortized in 2009 as the related customer orders closed. Amortization expense for these assets totaled $5.0 million, $5.0 million, and $5.9 million in 2011, 2010, and 2009, respectively, and is included within other expense (income), net.
We completed the business combination accounting in the second quarter of 2010. 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 our expectations regarding future operating results. As discussed in Note 11, 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. We also have experienced and anticipate future 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 $40.9 million for 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 with the Centex merger.
Supplemental pro forma information
The following represents pro forma operating results as if Centex had been included in the Condensed Consolidated Statements of Operations as of the beginning of the year ended December 31, 2009 ($000’s omitted, except per share data):
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.
PULTEGROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
3. Goodwill
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 noted in Note 2, we recorded $1.5 billion of goodwill in connection with the Centex merger. All goodwill associated with prior transactions had been previously written-off. We evaluate the recoverability of goodwill by comparing the carrying value of our reporting units to their fair value. Fair value is determined using 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 our geographical markets, and our strategic plans within each of our markets. Due to uncertainties in the estimation process and significant volatility in demand for new housing, actual results could differ significantly from such estimates.
As of December 31, 2011, all of the goodwill related to the Centex merger has been written-off as the result of a series of impairments. While the facts and circumstances at the date of each impairment varied, the primary drivers for the impairments were a significant decline in our market capitalization since the date of the Centex merger, in part due to overall volatility in the global financial markets, and ongoing challenges in market conditions for the homebuilding industry. In the third quarters of both 2011 and 2010, we performed event-driven assessments of the recoverability of goodwill. These assessments were necessary primarily due to sustained declines in our market capitalization. In performing the goodwill impairment analyses, we followed similar approaches using management's estimates of the future cash flows for each reporting unit, which are required to consider the decrease in our market capitalization. The results of these analyses determined that goodwill impairment charges of $240.5 million and $654.9 million in the third quarters of 2011 and 2010, respectively, were required. In the second quarter of 2010, we also recorded a goodwill impairment charge of $1.4 million in conjunction with the completion of business combination accounting for the Centex merger and disposed of $1.6 million of goodwill in connection with the sale of the retail title operations acquired with the Centex merger.
These impairments followed the initial impairment of goodwill related to the Centex merger that occurred as part of the annual goodwill impairment test performed in the fourth quarter of 2009. 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 our overall market capitalization. This valuation approach at the assessment date was consistent with our operating structure following the merger in that all acquired Centex operations were integrated with the PulteGroup 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, we determined that $563.0 million of goodwill was impaired. This impairment resulted from a number of factors, including:
•
a significant decline in our overall market capitalization between the Centex merger date and the goodwill assessment date, which implied that the fair values of our reporting units had decreased;
•
the requirement under ASC 350 to allocate all goodwill to our reporting units even though a significant portion of the goodwill was 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 our market capitalization to our stockholders' equity.
PULTEGROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Activity in our goodwill balances by reporting segment consisted of the following ($000's omitted):
Our accumulated goodwill impairment losses totaled $1.8 billion and $1.6 billion at December 31, 2011 and 2010, respectively. This includes goodwill and impairments associated with the Centex merger as well as goodwill and impairments associated with previous acquisitions. The goodwill associated with such previous acquisitions was fully impaired as of December 31, 2008. Goodwill impairment charges are reflected in other expense (income), net.
4. Restructuring
We have taken a series of actions both in response to the challenging operating environment and in connection with the 2009 Centex merger that were designed to reduce ongoing operating costs and improve operating efficiencies. As a result of the combination of these actions, we incurred total restructuring charges as summarized below ($000’s omitted):
* Includes $65.4 million of restructuring costs related to the Centex merger.
Of the total restructuring costs reflected in the above table, $1.2 million in 2011, $5.4 million in 2010, and $8.6 million in 2009 are classified within Financial Services expenses. All other employee severance benefits are included within selling, general and administrative expense while lease exit and other costs are included in other expense (income), net. The remaining liability for employee severance benefits and exited leases totaled $2.6 million and $29.7 million, respectively, at December 31, 2011 and $8.0 million and $41.7 million, respectively, at December 31, 2010. Substantially all of the remaining liability for employee severance benefits will be paid within the next year, while cash expenditures related to the remaining liability for 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 reportable segments and did not materially impact the comparability of any one segment.
PULTEGROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
5. Inventory and land held for sale
Major components of inventory at December 31, 2011 and 2010 were ($000’s omitted):
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 home closings. Interest expensed to Homebuilding cost of revenues for 2011, 2010, and 2009 included $5.4 million, $27.6 million, and $68.2 million, respectively, of capitalized interest related to inventory impairments. During 2011 and 2009, we capitalized all Homebuilding interest costs into inventory because the level of our active inventory exceeded our debt levels. During 2010, we capitalized all Homebuilding interest costs into inventory except $1.5 million that was expensed directly to interest expense due to our debt levels exceeding our active inventory levels for a portion of the year.
Information related to interest capitalized into inventory is as follows ($000’s omitted):
*
Homebuilding interest incurred includes interest on senior debt and other financing arrangements and excludes interest incurred by the Financial Services segment and certain other interest costs.
Land valuation adjustments and write-offs
Impairment of inventory
In accordance with ASC 360, “Property, Plant, and Equipment” (“ASC 360”), we record 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 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. We also consider 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. Communities that demonstrate potential impairment indicators are tested for impairment. We compare the expected undiscounted cash flows for these communities to their carrying value. For those communities whose carrying values exceed the expected undiscounted cash flows, we calculate 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.
We determine the fair value of a community's inventory 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
PULTEGROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
costs. 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 in the near term. 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. Our 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.
The table below provides, as of the date indicated, the number of communities for which we recognized impairment charges, the fair value of those communities at such date (net of impairment charges), and the amount of impairment charges recognized ($000’s omitted):
We recorded these valuation adjustments within Homebuilding home sale cost of revenues. In 2011, we reviewed each of our land positions for potential impairment indicators and performed detailed impairment calculations for approximately 100 communities. In determining the fair value for the impaired communities, we used discount rates ranging from 12% to 17%, with an aggregate average of 13%. During 2011, we experienced relative stability in market conditions generally consistent with our expectations, though at somewhat lower volumes, which resulted in total valuation adjustments significantly below those experienced in recent years. However, if conditions in the homebuilding industry or our local markets worsen in the future, if the current difficult market conditions extend beyond our expectations, or if our strategy related to certain communities changes, we may be required to evaluate our assets for future impairments or write-downs, which could result in future charges that might be significant.
Net realizable value adjustments - land held for sale
We acquire land primarily for the construction of homes for sale to customers but may periodically elect to sell select parcels of land to third parties for commercial or other development. Additionally, we may determine that certain land assets no longer fit into our strategic operating plans. Assuming the criteria in ASC 360 are met, we classify such land as land held for sale.
Land held for sale is valued at the lower of carrying value or fair value less costs to sell. In determining the fair value of land held for sale, we consider recent offers received, prices for land in recent comparable sales transactions, and other factors. During 2011, 2010, and 2009, we recognized net realizable value adjustments related to land held for sale of $9.8 million, $39.1 million, and $113.7 million, respectively. We record these net realizable value adjustments within Homebuilding land sale cost of revenues. During 2011, the land held for sale balance increased as the result of the reclassification from inventory of certain non-strategic parcels scheduled to be sold within the next year.
PULTEGROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Land held for sale at December 31, 2011 and 2010 was as follows ($000’s omitted):
Write-off of deposits and pre-acquisition costs
We write off deposits and pre-acquisition costs related to land option contracts when it becomes probable that we will not go forward with the project or recover the capitalized costs. Such decisions take into consideration changes in local market conditions, the willingness of land sellers to modify terms of the related purchase agreements, the timing of required land takedowns, the availability and best use of necessary incremental capital, and other factors. We wrote off (net of recoveries) deposits and pre-acquisition costs in the amount of $10.0 million, $5.6 million, and $54.3 million, during 2011, 2010, and 2009, respectively. We record these write-offs of deposits and pre-acquisition costs within other expense (income), net.
6. Segment information
Our Homebuilding operations are engaged in the acquisition and development of land primarily for residential purposes within the U.S. and the construction of housing on such land. Home sale revenues for detached and attached homes were $3.1 billion and $841.3 million in 2011, $3.5 billion and $936.6 million in 2010, and $3.0 billion and $851.9 million in 2009, respectively.
For reporting purposes, our Homebuilding operations are aggregated into six reportable segments. During 2011, we realigned our organizational structure and reportable segment presentation. Accordingly, the segment information provided in this note has been reclassified to conform to the current presentation for all periods presented.
Northeast:
Connecticut, Delaware, Maryland, Massachusetts, New Jersey, New York, Pennsylvania,
Rhode Island, Virginia
Southeast:
Georgia, North Carolina, South Carolina, Tennessee
Florida:
Florida
Texas:
Texas
North:
Illinois, Indiana, Michigan, Minnesota, Missouri, Northern California, Ohio, Oregon, Washington
Southwest:
Arizona, Colorado, Hawaii, Nevada, New Mexico, Southern California
As part of the change in presentation, we removed the "Other non-operating" distinction. Amounts previously classified within "Other non-operating" have been reclassified to "Other homebuilding."
We also have one reportable segment for our Financial Services operations, which consist principally of mortgage banking and title operations. The Financial Services segment operates generally in the same markets as the Homebuilding segments.
Evaluation of segment performance is generally based on income before income taxes. Each reportable segment generally follows the same accounting policies described in Note 1 "Summary of Significant Accounting Policies" to the consolidated financial statements.
PULTEGROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(a)
Other homebuilding includes the amortization of intangible assets, goodwill impairment, amortization of capitalized interest, net losses related to the redemption of debt, and other costs not allocated to the operating segments.
(b)
Financial Services income (loss) before income taxes includes interest expense of $1.6 million and $2.3 million for 2010 and 2009, respectively, and interest income of $5.0 million, $5.8 million, and $7.7 million for 2011, 2010, and 2009, respectively.
PULTEGROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(a)
Primarily write-offs of capitalized interest related to land and community valuation adjustments.
(b)
Includes settlements related to costs previously in dispute and considered non-recoverable.
(c)
Includes impairments related to joint ventures located in Puerto Rico.
PULTEGROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(a)
Other homebuilding includes amortization of intangible assets.
(a)
Includes impairments related to investments in unconsolidated joint ventures.
PULTEGROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(a)
Other homebuilding primarily includes capitalized interest, cash and equivalents, goodwill, income taxes receivable, intangibles, and other corporate items that are not allocated to the operating segments.
PULTEGROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
7. Investments in unconsolidated entities
We participate 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 U.S. and Puerto Rico. A summary of our joint ventures is presented below ($000’s omitted):
In 2011, 2010, and 2009, we recognized (income) expense from unconsolidated joint ventures of $(3.3) million, $(2.9) million, and $49.7 million, respectively. The (income) expense recognized during 2010 and 2009 includes impairments totaling $1.9 million,and $54.1 million, respectively. During 2011, 2010, and 2009, we made capital contributions of $4.6 million, $22.9 million, and $35.1 million, respectively, and received capital and earnings distributions of $11.6 million, $9.7 million, and $9.5 million, respectively.
The timing of cash obligations under the joint venture and any 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 contributions are required and approved, we would need to contribute our pro rata portion of those capital needs in order to not dilute our ownership in the joint ventures. While future capital contributions may be required, we believe the total amount of such contributions will be limited. Our maximum financial loss exposure related to joint ventures is unlikely to exceed the combined investment and limited recourse guaranty totals.
PULTEGROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
8. Debt
Our senior notes are summarized as follows ($000’s omitted):
(a)
Not redeemable prior to maturity, guaranteed on a senior basis by certain wholly-owned subsidiaries
(b)
Redeemable prior to maturity, guaranteed on a senior basis by certain wholly-owned subsidiaries
(c)
The recorded carrying value reflects the impact of various discounts and premiums that are amortized to interest cost over the respective terms of the senior notes
Refer to Note 16 for supplemental consolidating financial information of the Company.
The indentures governing the senior notes impose certain restrictions on the incurrence of additional debt along with other limitations. At December 31, 2011, we were in compliance with all of the covenants and requirements under the senior notes.
Total senior note principal maturities during the five years after 2011 are as follows: 2012 - $96.4 million; 2013 - $182.2 million; 2014 - $574.6 million; 2015 - $492.5 million; 2016 - $480.0 million; and thereafter - $1.3 billion.
Debt retirement
During the last three years, we reduced our outstanding senior notes through a variety of transactions ($000’s omitted):
PULTEGROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
PULTEGROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
We recorded losses related to these transactions totaling $5.6 million, $38.9 million, and $31.6 million in 2011, 2010 and 2009, respectively. Losses on these transactions include the write-off of unamortized discounts, premiums, and transaction fees and are reflected in other expense (income), net.
Letter of credit facilities
As a cost-saving measure and to provide increased operational flexibility, we voluntarily terminated our $250.0 million unsecured revolving credit facility ("the Credit Facility") effective March 30, 2011. The Credit Facility was scheduled to expire in June 2012 and was being used solely to issue letters of credit ($221.6 million outstanding at December 31, 2010). No borrowings were outstanding under the Credit Facility during 2011, 2010, or 2009. We did not pay any penalties as a result of the termination. The termination of the Credit Facility also:
•
released $250.0 million of cash required to be maintained in liquidity reserve accounts; and
•
resulted in expense of $1.3 million related to the write-off of unamortized issuance costs, which is included within selling, general, and administrative expenses during 2011.
In connection with the termination of the Credit Facility, we entered into separate cash-collateralized letter of credit agreements with a number of financial institutions. These agreements provide capacity to issue letters of credit totaling up to $191.2 million, the majority of which is uncommitted. Letters of credit totaling $83.2 million were outstanding under these agreements at December 31, 2011. Under these agreements, we are required to maintain deposits with these financial institutions in amounts approximating the letters of credit outstanding. Such deposits are included in restricted cash.
We also maintain an unsecured letter of credit facility with a bank that expires in June 2014. This facility permits the issuance of up to $200.0 million of letters of credit for general corporate purposes in support of any wholly-owned subsidiary. At December 31, 2011 and 2010, $152.7 million and $167.2 million, respectively, of letters of credit were outstanding under this facility.
Financial Services
Pulte Mortgage provides mortgage financing for many of our home closings utilizing its own funds and funds available pursuant to a repurchase agreement with the Company. Pulte Mortgage uses these resources to finance its lending activities until the mortgage loans are sold to third party investors, generally within 30 days. Given our current liquidity position and the cost of third party financing relative to existing mortgage rates, Pulte Mortgage allowed each of its third party borrowing arrangements to expire during 2010 and began funding its operations using internal Company resources. In order to satisfy regulatory requirements in certain states, Pulte Mortgage maintains a $2.5 million repurchase lending agreement with a bank that expires in October 2012. There were no borrowings outstanding under this facility at December 31, 2011.
The following is aggregate borrowing information for our mortgage operations ($000’s omitted):
Borrowings under Pulte Mortgage’s credit lines are secured by residential mortgage loans available-for-sale. The carrying amounts of such borrowings approximate fair value.
PULTEGROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
9. Shareholders’ equity
Pursuant to the two $100.0 million stock repurchase programs authorized by the Board of Directors in October 2002 and October 2005, and the $200.0 million stock repurchase authorization in February 2006 (for a total stock repurchase authorization of $400.0 million), we have repurchased a total of 9,688,900 shares for a total of $297.7 million, though there were no repurchases under these programs during 2011, 2010, or 2009. At December 31, 2011, we had remaining authorization to purchase $102.3 million of common stock.
Under our stock-based compensation plans, we accept 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 2011, 2010, and 2009, we repurchased $2.8 million, $4.0 million, and $7.4 million, respectively, of shares from employees under these plans. Such repurchases are excluded from the $400.0 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):
PULTEGROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
10. Stock compensation plans
We maintain stock option plans for both employees and for non-employee directors. Information related to the active plans as of December 31, 2011 is as follows:
The plans provide for the grant of a variety of equity awards, including options (generally non-qualified options), restricted stock, performance shares, and restricted stock units ("RSUs") to key employees (as determined by the Compensation Committee of the Board of Directors) for periods not exceeding ten years. Options granted to employees generally vest incrementally over four years. Restricted stock generally cliff vests after three years. Performance shares vest upon attainment of the stated performance goals and are converted into shares of common stock at distribution. RSUs represent the right to receive an equal number of shares of common stock and are converted into shares of common stock upon distribution.
Non-employee directors are entitled to an annual distribution of stock options, common stock, or restricted stock units. All options and RSUs granted to non-employee directors vest immediately and are exercisable on the grant date for ten years.
A summary of stock option activity for the three years ended December 31, 2011 is presented below (000’s omitted except per share data):
(a)
2009 includes 5.3 million options issued in conjunction with the Centex merger.
PULTEGROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
The following table summarizes information about the weighted-average remaining contractual lives of stock options outstanding and exercisable at December 31, 2011:
The fair value of each option grant is estimated on the date of grant using primarily the Black-Scholes option pricing model with the following weighted-average assumptions:
We estimate the expected life of stock options using employees’ historical exercise behavior and the contractual terms of the instruments. Volatility is estimated using historical volatility with consideration for implied volatility.
In connection with stock option awards, we recognized compensation expense of $5.2 million, $15.0 million, and $22.1 million for the years ended December 31, 2011, 2010, and 2009, respectively. Total compensation cost related to non-vested stock option awards not yet recognized was $3.2 million at December 31, 2011. These costs will be expensed over a weighted-average vesting period of approximately two years. The stock option participant agreements provide continued vesting for certain eligible employees who have achieved a predetermined level of service based on their combined age and years of service. We record the related compensation cost for these awards over the period through the date the employee first achieves the minimum level of service that would no longer require them to provide services to earn the award, which is reflected in the weighted-average vesting period.
No stock options were exercised during 2011. The aggregate intrinsic value of stock options that were exercised during 2010 and 2009 was $1.8 million and $3.3 million, respectively. The intrinsic value of a stock option is the amount by which the market value of the underlying stock exceeds the exercise price of the option. As of December 31, 2011, there were no outstanding options with intrinsic value.
PULTEGROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
A summary of restricted stock activity for the three years ended December 31, 2011 is presented below (000’s omitted, except per share data):
During 2011, 2010, and 2009, the total fair value of shares vested during the year was $15.9 million, $32.2 million, and $48.1 million, respectively. In connection with the restricted stock awards, we recorded compensation expense of $11.2 million, $17.1 million, and $24.2 million during 2011, 2010, and 2009, respectively. Total compensation cost related to restricted stock awards not yet recognized was $10.0 million at December 31, 2011. These costs will be expensed over a weighted-average period of approximately two years.
A summary of share unit (performance shares and RSUs) activity for the three years ended December 31, 2011 is presented below (000’s omitted, except per share data):
During 2011, we granted performance shares to certain individuals but did not recognize any expense as the applicable performance goals were not considered probable of achievement. The fair value of each performance share and RSU was calculated using the closing stock price on the date of grant. At December 31, 2011, there were 119,799 RSUs outstanding that had vested but had not yet been paid out because the payout date had been deferred by the holder.
PULTEGROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
11. Income taxes
Components of current and deferred income tax expense (benefit) are as follows ($000’s omitted):
The following table reconciles the statutory federal income tax rate to the effective income tax rate:
The net deferred tax asset (liability) is as follows ($000’s omitted):
PULTEGROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Our income tax expense (benefit) was $(99.9) million, $(137.8) million, and $(792.6) million in 2011, 2010, and 2009, respectively. These amounts represent effective tax rates of 32.2%, 11.2%, and 40.1% for 2011, 2010, and 2009, respectively. Due to the effects of the deferred tax valuation allowance and changes in unrecognized tax benefits, our effective tax rates in 2011, 2010, and 2009 are not correlated to the amount of pretax loss. The income tax benefits for 2011 and 2010 resulted primarily from the favorable resolution of certain federal and state income tax matters. The income tax benefit for 2009 related primarily to the impact of 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 NOLs realized in either tax year 2008 or 2009 to be carried back up to five years (previously limited to two years).
We had income taxes receivable of $27.2 million and $81.3 million at December 31, 2011 and 2010, respectively. The income taxes receivable at December 31, 2011 related primarily to amended federal and state income tax returns. The income taxes receivable at December 31, 2010 related primarily to federal income tax refunds from amended returns and state NOL carrybacks, the majority of which was received in 2011.
We had net deferred tax assets of $2.5 billion and $2.6 billion at December 31, 2011 and 2010. Based on our evaluation in accordance with ASC 740, we fully reserved the net deferred tax assets 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 estimated and actual results could have a material impact on our consolidated results of operations or financial position. To the extent that our results of operations improve, our deferred tax asset valuation allowance may be reduced.
As a result of the Centex merger, our ability to use certain of Centex’s pre-ownership change NOLs and built-in losses or deductions is limited by Section 382 of the Internal Revenue Code. Our Section 382 limitation is approximately $67.4 million per year for NOLs, losses realized on built-in loss assets that are sold within 60 months of the ownership change (i.e. before August 2014), and certain deductions. The limitation may result in a significant portion of Centex’s pre-ownership change NOL carryforwards and future recognized built-in losses or deductions not being available for use by the Company.
Our gross federal NOL carryforward is approximately $1.9 billion, a significant portion of which is subject to the provisions of Internal Revenue Code Section 382. We also have significant gross state NOLs in various tax jurisdictions. These NOLs may be carried forward from 5 to 20 years, depending on the tax jurisdiction, with losses expiring between 2012 and 2031.
At December 31, 2011 we had $171.9 million of gross unrecognized tax benefits, of which $170.6 million would affect the effective tax rate if recognized. At December 31, 2010, we had $258.0 million of gross unrecognized tax benefits, of which $250.7 million would affect the effective rate if recognized. Additionally, we had accrued interest and penalties of $36.9 million and $48.4 million at December 31, 2011 and 2010, respectively. In 2011 and 2010, our income tax benefits included tax related interest and penalties. Such amounts totaled a benefit of $11.4 million in 2011 and $27.3 million in 2010.
We are currently under examination by the IRS and various state taxing jurisdictions and anticipate finalizing certain of the examinations within the next twelve months. The final outcome of these examinations is not yet determinable. It is reasonably possible, within the next twelve months, that unrecognized tax benefits may decrease by up to $26.5 million, excluding interest and penalties, primarily due to expirations of certain statutes of limitations and potential settlements. The statute of limitations for our major tax jurisdictions remains open for examination for tax years 1998 to 2011.
PULTEGROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
A reconciliation of the change in the unrecognized tax benefits is as follows ($000’s omitted):
12. Fair value disclosures
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:
Level 1
Fair value determined based on quoted prices in active markets for identical assets or liabilities.
Level 2
Fair value determined using significant observable inputs, generally either quoted prices in active markets for similar assets or liabilities or quoted prices in markets that are not active.
Level 3
Fair value determined using significant unobservable inputs, such as pricing models, discounted cash flows, or similar techniques
Our financial instruments measured at fair value on a recurring basis at December 31, 2011 and 2010 are summarized below ($000’s omitted):
See Note 1 regarding the fair value of mortgage loans available-for-sale and derivative instruments and hedging activities.
In addition, certain 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. Assets measured at fair value on a non-recurring basis at December 31, 2011 and 2010 are summarized below ($000’s omitted):
PULTEGROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
The fair values included in the table above represent only those assets whose carrying values were adjusted to fair value in the current quarter. We measured certain 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 inventory, see Note 5 for a more detailed discussion of the valuation methods used.
The carrying amounts of cash and equivalents approximate their fair values due to their short-term nature. The fair value of senior notes outstanding totaled $2.8 billion compared with the carrying value of $3.1 billion. 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. The carrying value of collateralized short-term financing agreements approximates fair value.
13. Other assets and accrued and other liabilities
Other assets are presented below ($000’s omitted):
Accrued and other liabilities are presented below ($000’s omitted):
PULTEGROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
14. Leases
We lease certain property and equipment under non-cancelable operating leases. The future minimum lease payments required under operating leases that have initial or remaining non-cancelable terms in excess of one year as of December 31, 2011 are as follows ($000’s omitted):
(a)
Minimum payments have not been reduced by minimum sublease rentals of $14.6 million due in the future under non-cancelable subleases.
Net rental expense for 2011, 2010, and 2009 was $26.7 million, $37.2 million, and $48.7 million, respectively, excluding lease exit costs presented in Note 4. Certain leases contain renewal or purchase options and generally provide that we pay for insurance, taxes, and maintenance.
15. Commitments and Contingencies
Loan origination liabilities
Our mortgage operations may be responsible for losses associated with mortgage loans originated and sold to investors in the event of errors or omissions relating to representations and warranties that the loans sold meet certain requirements, including representations as to underwriting standards, the existence of primary mortgage insurance, and the validity of certain borrower representations in connection with the loan. If determined to be at fault, we either repurchase the loans from the investors or reimburse the investors' losses (a “make-whole” payment).
We sell a substantial majority of the loans we originate to investors each month, retaining limited risk related to such loans. Historically, our overall losses relating to this risk were not significant. Beginning in 2009, however, we experienced a significant increase in 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. To date, the significant majority of these losses relates to loans originated in 2006 and 2007, during which period inherently riskier loan products became more common in the mortgage origination market. In 2006 and 2007, we originated $39.5 billion of loans, excluding loans originated by Centex's former subprime loan business sold by Centex in 2006. Because we generally do not retain the servicing rights to the loans we originate, information regarding the current and historical performance, credit quality, and outstanding balances of such loans is limited. Estimating these loan origination liabilities is further complicated by uncertainties surrounding numerous external factors, such as various macroeconomic factors (including unemployment rates and changes in home prices), actions taken by third parties, including the parties servicing the loans, and the U.S. federal government in its dual capacity as regulator of the U.S. mortgage industry and conservator of the government-sponsored enterprises commonly known as Fannie Mae and Freddie Mac, which own or guarantee the majority of mortgage loans in the U.S.
Most requests received to date relate to make-whole payments on loans that have been foreclosed, generally after a portion of the loan principal had been paid down, which reduces our exposure. Requests not immediately refuted by us undergo extensive analysis to confirm the exposure, attempt to cure the identified defect, and, when necessary, determine our liability. We establish liabilities for such anticipated losses based upon, among other things, the level of current unresolved repurchase requests, the volume of estimated probable future repurchase requests, our ability to cure the defects identified in the repurchase requests, and the severity of the estimated loss upon repurchase. Determining these estimates and the resulting liability requires a significant level of management judgment. We are generally able to cure or refute over 60% of the requests received from investors such that repurchases or make-whole payments are not required. For those requests requiring repurchases or make-whole payments, actual loss severities generally approximate 50% of the outstanding principal balance.
PULTEGROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
During 2011, 2010, and 2009, we recorded additional provisions for losses as a change in estimate primarily to reflect projected claim volumes in excess of previous estimates. Such provisions for losses are reflected in Financial Services expenses. Our current estimates assume that claim volumes will not decline to pre-2009 levels until after 2013, an extension of two years beyond our previous estimates as of December 31, 2010. 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 were as follows ($000's omitted):
As reflected above, we assumed loan origination liabilities totaling $56.3 million effective with the Centex merger.
We entered into an agreement in conjunction with the wind down of Centex's mortgage operations, which ceased loan origination activities in December 2009, that provides a guaranty for one major investor of loans originated by Centex. This guaranty provides that we 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 our mortgage subsidiaries, which are included in non-guarantor subsidiaries (see Note 16 for a discussion of non-guarantor subsidiaries).
The mortgage subsidiary of Centex also sold loans to a bank for inclusion in residential mortgage-backed securities (“RMBSs”) issued by the bank. In connection with these sales, Centex's mortgage subsidiary entered into agreements pursuant to which it may be required to indemnify the bank for losses incurred by investors in the RMBSs arising out of material errors or omissions in certain information provided by the mortgage subsidiary relating to the loans and loan origination process. The bank has notified us that it has been named defendant in two lawsuits alleging various violations of federal and state securities laws asserting that untrue statements of material fact were included in the registration statements used to market the sale of two RMBS transactions which included $162 million of loans originated by Centex's mortgage subsidiary. The plaintiffs seek unspecified compensatory and/or rescissory damages on behalf of persons who purchased the securities. Neither Centex's mortgage subsidiary nor the Company is named as a defendant in these actions. These actions are in their preliminary stage, and we cannot yet quantify Centex's mortgage subsidiary's potential liability as a result of these indemnification obligations. We do not believe, however, that these matters will have a material adverse impact on the results of operations, financial position, or cash flows of the Company. We are aware of six other RMBS transactions with such indemnity provisions that include an aggregate $116 million of loans, and we are not aware of any current or threatened legal proceedings regarding those transactions.
Mortgage reinsurance liabilities
A subsidiary of Pulte Mortgage operates as a re-insurer for a portion of the mortgage insurance written on loans originated by Pulte Mortgage. Such reinsurance programs were discontinued effective January 1, 2009. At December 31, 2011 and 2010, reserves for potential claims under this program totaled $2.8 million and $7.6 million, respectively, and are reflected in accrued and other liabilities.
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, we are only responsible for paying the special assessments for the period in which we are the landowner of the applicable parcels. However, in certain limited instances we record 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 December 31, 2011 and 2010, we had recorded $38.4 million and $73.3 million, respectively, in accrued liabilities for outstanding CDD obligations. During 2011 and 2010, we repurchased at a discount prior to their maturity CDD obligations with aggregate principal balances of $26.6 million and $124.1 million, respectively, in order to
PULTEGROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
improve the future financial performance of the related communities. The discounts of $5.2 million in 2011 and $12.9 million in 2010 are recognized as a reduction of cost of revenues over the lives of the applicable communities, which extend for several years.
Letters of credit and surety bonds
In the normal course of business, we post letters of credit and surety bonds pursuant to certain performance-related obligations, as security for certain land option agreements, and under various insurance programs. The majority of these letters of credit and surety bonds are in support of our land development and construction obligations to various municipalities, other government agencies, and utility companies related to the construction of roads, sewers, and other infrastructure. We had outstanding letters of credit and surety bonds totaling $235.9 million and $1.2 billion at December 31, 2011, respectively, and $388.9 million and $1.3 billion at December 31, 2010, respectively. In the event any such letter of credit or surety bonds are called, we would be obligated to reimburse the issuer of the letter of credit or surety bond. We do not believe that a material amount, if any, of the letters of credit or surety bonds will be called. Our surety bonds generally do not have stated expiration dates. Rather, we are released from the surety bonds as the underlying performance is completed and accepted by the applicable counterparty. Because significant construction and development work has been performed related to the applicable projects but has not yet received final acceptance by the respective counterparties, the aggregate amount of surety bonds outstanding is in excess of the projected cost of the remaining work to be performed.
Litigation and regulatory matters
We are involved in various litigation and legal claims in the normal course of our business operations, including actions brought on behalf of various classes of claimants. We are also subject to a variety of local, state, and federal laws and regulations related to land development activities, house construction standards, sales practices, mortgage lending operations, employment practices, and protection of the environment. As a result, we are subject to periodic examination or inquiry by various governmental agencies that administer these laws and regulations.
We establish liabilities for legal claims and regulatory matters when such matters are both probable of occurring and any potential loss is reasonably estimable. We accrue for such matters based on the facts and circumstances specific to each matter and revise these estimates as the matters evolve. In such cases, there may exist an exposure to loss in excess of any amounts currently accrued. In view of the inherent difficulty of predicting the outcome of these legal and regulatory matters, we generally cannot predict the ultimate resolution of the pending matters, the related timing, or the eventual loss. While the outcome of such contingencies cannot be predicted with certainty, we do not believe that the resolution of such matters will have a material adverse impact on our results of operations, financial position, or cash flows. However, to the extent the liability arising from the ultimate resolution of any matter exceeds the estimates reflected in the recorded reserves relating to such matter, we could incur additional charges that could be significant.
Allowance for warranties
Home purchasers are provided with a limited warranty against certain building defects, including a one-year comprehensive limited warranty and coverage for certain other aspects of the home’s construction and operating systems for periods of up to ten years. We estimate the costs to be incurred under these warranties and record liabilities in the amount of such costs at the time product revenue is recognized. Factors that affect our warranty liabilities include the number of homes sold, historical and anticipated rates of warranty claims, and the cost per claim. We periodically assess the adequacy of the warranty liabilities for each geographic market in which we operate and adjust the amounts as necessary. Actual warranty costs in the future could differ from the current estimates.
Changes to warranty liabilities were as follows ($000’s omitted):
PULTEGROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Self-insured risks
We maintain, and require our subcontractors to maintain, general liability insurance coverage. We also maintain builders' risk, property, errors and omissions, workers compensation, and other business insurance coverage. These insurance policies protect us against a portion of the risk of loss from claims. However, we retain a significant portion of the overall risk for such claims either through policies issued by our captive insurance subsidiaries or through our own self-insured per occurrence and aggregate retentions, deductibles, and claims in excess of available insurance policy limits.
Our general liability insurance includes coverage for certain construction defects. While construction defect claims can relate to a variety of circumstances, the majority of our claims relate to alleged problems with siding, plumbing, foundations and other concrete work, windows, roofing, and heating, ventilation and air conditioning systems. The availability of general liability insurance for the homebuilding industry and its subcontractors has become increasingly limited, and the insurance policies available require companies to maintain higher per occurrence and aggregate retention levels. In certain instances, we may offer our subcontractors the opportunity to purchase insurance through one of our captive insurance subsidiaries or to participate in a project-specific insurance program provided by the Company. Policies issued by the captive insurance subsidiaries represent self-insurance of these risks by the Company. This self-insured exposure is limited by reinsurance policies that we purchase. General liability coverage for the homebuilding industry is complex, and our coverage varies from policy year to policy year. We are self-insured for a per occurrence deductible, which is capped at an overall aggregate retention level. Beginning with the first dollar, amounts paid on insured claims satisfy our per occurrence and aggregate retention obligations. Any amounts incurred in excess of the occurrence or aggregate retention levels are covered by insurance up to our purchased coverage levels. Our insurance policies, including the captive insurance subsidiaries' reinsurance policies, are maintained with highly-rated underwriters for whom we believe counterparty default risk is not significant.
At any point in time, we are managing over 1,000 individual claims related to general liability, property, errors and omission, workers compensation, and other business insurance coverage. We reserve for costs associated with such claims (including expected claims management expenses relating to legal fees, expert fees, and claims handling expenses) on an undiscounted basis at the time product revenue is recognized for each home closing and evaluate the recorded liabilities based on actuarial analyses of our historical claims. The actuarial analyses calculate an estimate of the ultimate net cost of all unpaid losses, including estimates for incurred but not reported losses ("IBNR"). IBNR represents losses related to claims incurred but not yet reported plus development on reported claims. These estimates make up a significant portion of our liability 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 construction defect claims are reported and resolved over an extended period often exceeding ten years. In certain instances, we have the ability to recover a portion of our costs under various insurance policies or from subcontractors or other third parties. Estimates of such amounts are recorded when recovery is considered probable.
Our recorded reserves for all such claims totaled $741.4 million and $785.6 million at December 31, 2011 and 2010, respectively, the vast majority of which relate to general liability claims. The recorded reserves include loss estimates related to both (i) existing claims and related claim expenses and (ii) IBNR and related claim expenses. Liabilities related to IBNR and related claim expenses represented approximately 78% of the total general liability reserves at both December 31, 2011 and 2010. The actuarial analyses that determine the IBNR portion of reserves consider a variety of factors, including the frequency and severity of losses, which are based on our historical claims experience supplemented by industry data. The actuarial analyses of the reserves also consider historical third party recovery rates and claims management expenses.
Adjustments to estimated reserves are recorded in the period in which the change in estimate occurs. Because the majority of our recorded reserves relates to IBNR, adjustments to reserve amounts for individual existing claims generally do not impact the recorded reserves materially. However, changes in the frequency and timing of reported claims and the estimates of specific claim values can impact the underlying inputs and trends utilized in the actuarial analyses, which could have a material impact on the recorded reserves. Because of the inherent uncertainty in estimating future losses related to these claims, actual costs could differ significantly from estimated costs.
We have experienced a high level of insurance-related expenses in recent years, primarily due to the adverse development of general liability claims, the frequency and severity of which have increased significantly over historical levels. During 2010, we experienced a greater than anticipated frequency of newly reported claims and a significant increase in specific case reserves related to certain known claims. The general nature of these claims was not out of the
PULTEGROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
ordinary, but the frequency and severity of the claims were in excess of our historical experience. As a result of these unfavorable trends, we recorded additional reserves totaling $280.4 million ($0.74 per basic and diluted share) within selling, general, and administrative expenses. Substantially all of this additional reserve related to general liability exposures, a large portion of which resulted from revising our actuarial assumptions surrounding the long-term frequency, severity, and development of claims. During the industry downturn over the last several years, and especially in 2010, we experienced adverse claim frequency and severity compared with longer term averages. In 2010, we deemed it appropriate to assume that the long-term future frequency, severity, and development of claims will most closely resemble the claims activity experienced in recent years.
Changes in these liabilities were as follows ($000's omitted):
As reflected in the above table, we assumed insurance-related liabilities of $271.1 million effective with the Centex merger, which were increased by $2.5 million upon completion of a final valuation in 2010. The reserves provided reflected in the above table are classified within selling, general, and administrative expenses.
16. Supplemental Guarantor information
All of our 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.
PULTEGROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
CONSOLIDATING BALANCE SHEET
DECEMBER 31, 2011
($000’s omitted)
PULTEGROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
CONSOLIDATING BALANCE SHEET
DECEMBER 31, 2010
($000’s omitted)
PULTEGROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
CONSOLIDATING STATEMENT OF OPERATIONS
For the year ended December 31, 2011
($000’s omitted)
PULTEGROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
CONSOLIDATING STATEMENT OF OPERATIONS
For the year ended December 31, 2010
($000’s omitted)
PULTEGROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
CONSOLIDATING STATEMENT OF OPERATIONS
For the year ended December 31, 2009
($000’s omitted)
PULTEGROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
CONSOLIDATING STATEMENT OF CASH FLOWS
For the year ended December 31, 2011
($000’s omitted)
PULTEGROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
CONSOLIDATING STATEMENT OF CASH FLOWS
For the year ended December 31, 2010
($000’s omitted)
PULTEGROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
CONSOLIDATING STATEMENT OF CASH FLOWS
For the year ended December 31, 2009
($000’s omitted)
PULTEGROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
17. Quarterly Results (Unaudited)
UNAUDITED QUARTERLY INFORMATION
(000’s omitted, except per share data)
(a)
Cost of revenues includes land and community valuation adjustments of $0.1 million, $3.3 million, $1.5 million, and $11.0 million and net realizable value adjustments of $0.0 million, $(0.2) million, $0.1 million, and $9.9 million for the 1st Quarter, 2nd Quarter, 3rd Quarter, and 4th Quarter, respectively.
(b)
Income (loss) before income taxes includes the write-off (recovery) of deposits and pre-acquisition costs of $0.6 million, $3.7 million, $2.3 million, and $3.4 million for the 1st Quarter, 2nd Quarter, 3rd Quarter, and 4th Quarter, respectively. Income (loss) before income taxes also includes goodwill impairments of $240.5 million for the 3rd Quarter. Homebuilding income (loss) before income taxes includes amounts previously classified within Other Non-Operating.
PULTEGROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
UNAUDITED QUARTERLY INFORMATION
(000’s omitted, except per share data)
(a)
Cost of revenues includes land and community valuation adjustments of $4.5 million, $25.5 million, $57.5 million, and $82.2 million and net realizable value adjustments of $0.6 million, $(0.2) million, $0.6 million, and $38.1 million for the 1st Quarter, 2nd Quarter, 3rd Quarter, and 4th Quarter, respectively.
(b)
Income (loss) before income taxes includes the write-off (recovery) of deposits and pre-acquisition costs of $0.5 million, $2.3 million, $1.1 million, and $1.6 million for the 1st Quarter, 2nd Quarter, 3rd Quarter, and 4th Quarter, respectively. Income (loss) before income taxes also includes impairments of investments of unconsolidated joint ventures of $1.9 million for the 1st Quarter and goodwill impairments of $1.4 million and $654.9 million for the 2nd Quarter and 3rd Quarter, respectively. Income (loss) before income taxes also includes insurance-related charges of $10.0 million, $9.6 million, $272.2 million, and $(11.4) million for the 1st Quarter, 2nd Quarter, 3rd Quarter, and 4th Quarter, respectively. Homebuilding income (loss) before income taxes includes amounts previously classified within Other Non-Operating.
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders
of PulteGroup, Inc.
We have audited the accompanying consolidated balance sheets of PulteGroup, Inc. (the “Company”) as of December 31, 2011 and 2010, and the related consolidated statements of operations, shareholders’ equity and comprehensive income (loss), and cash flows for each of the three years in the period ended December 31, 2011. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of PulteGroup, Inc. at December 31, 2011 and 2010, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2011, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), PulteGroup, Inc.’s internal control over financial reporting as of December 31, 2011, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 9, 2012 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
Detroit, Michigan
February 9, 2012
ITEM 9.
CHANGES IN AND DISAGREEMENT WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES
This Item is not applicable.
ITEM 9A. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
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 December 31, 2011. 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 December 31, 2011.
Internal Control Over Financial Reporting
(a)
Management’s Annual Report on Internal Control Over Financial Reporting
Management is responsible for the preparation and fair presentation of the consolidated financial statements included in this annual report. The consolidated financial statements have been prepared in conformity with United States generally accepted accounting principles and reflect management’s judgments and estimates concerning events and transactions that are accounted for or disclosed.
Management is also responsible for establishing and maintaining effective internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). Management recognizes that there are inherent limitations in the effectiveness of any internal control and effective internal control over financial reporting can provide only reasonable assurance with respect to financial statement preparation. Additionally, because of changes in conditions, the effectiveness of internal control over financial reporting may vary over time.
In order to ensure that the Company’s internal control over financial reporting is effective, management regularly assesses such controls and did so most recently for its financial reporting as of December 31, 2011. Management’s assessment was based on criteria for effective internal control over financial reporting described in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, management asserts that the Company has maintained effective internal control over financial reporting as of December 31, 2011.
Ernst & Young LLP, the independent registered public accounting firm that audited the Company’s consolidated financial statements included in this annual report, has issued its report on the effectiveness of the Company’s internal control over financial reporting as of December 31, 2011.
(b)
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders of PulteGroup, Inc.
We have audited PulteGroup, Inc.’s internal control over financial reporting as of December 31, 2011, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). PulteGroup, Inc.’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Annual Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, PulteGroup, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2011, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of PulteGroup, Inc. as of December 31, 2011 and 2010, and the related consolidated statements of operations, shareholders’ equity and comprehensive income (loss), and cash flows for each of the three years in the period ended December 31, 2011 and our report dated February 9, 2012 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
Detroit, Michigan
February 9, 2012
(c)
Changes in Internal Control Over Financial Reporting
There has been no change in our internal control over financial reporting during the quarter ended December 31, 2011 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
ITEM 9B. OTHER INFORMATION
This Item is not applicable.
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Information required by this Item with respect to our executive officers is set forth in Item 4A of this Annual Report on Form 10-K. Information required by this Item with respect to members of our Board of Directors and with respect to our audit committee will be contained in the Proxy Statement for the 2012 Annual Meeting of Shareholders (“2012 Proxy Statement”) under the captions “Election of Directors” and “Committees of the Board of Directors - Audit Committee” and in the chart disclosing Audit Committee membership and is incorporated herein by this reference. Information required by this Item with respect to compliance with Section 16(a) of the Securities Exchange Act of 1934 will be contained in the 2012 Proxy Statement under the caption “Beneficial Security Ownership - Section 16(a) Beneficial Ownership Reporting Compliance,” and is incorporated herein by this reference. Information required by this Item with respect to our code of ethics will be contained in the 2012 Proxy Statement under the caption “Corporate Governance - Governance Guidelines; Code of Ethical Business Conduct; Code of Ethics” and is incorporated herein by this reference.
Our code of ethics for principal officers, our code of ethical business conduct, our corporate governance guidelines, and the charters of the Audit, Compensation and Management Development, Nominating and Governance, and Finance and Investment committees of our Board of Directors are also posted on our website and are available in print, free of charge, upon request.
ITEM 11.
EXECUTIVE COMPENSATION
Information required by this Item will be contained in the 2012 Proxy Statement under the captions “2011 Executive Compensation” and “2011 Director Compensation” and is incorporated herein by this reference, provided that the Compensation and Management Development Committee Report shall not be deemed to be “filed” with this Annual Report on Form 10-K.
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLER MATTERS
Information required by this Item will be contained in the 2012 Proxy Statement under the captions “Beneficial Security Ownership” and “Equity Compensation Plan Information” and is incorporated herein by this reference.
ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE
Information required by this Item will be contained in the 2012 Proxy Statement under the captions “Certain Relationships and Related Transactions” and “Election of Directors - Independence” and is incorporated herein by this reference.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Information required by this Item will be contained in the 2012 Proxy Statement under the captions “Audit and Non-Audit Fees” and “Audit Committee Preapproval Policies” and is incorporated herein by reference.
PART IV
ITEM 15.
EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a)
The following documents are filed as part of this Annual Report on Form 10-K:
(1) Financial Statements
Consolidated Balance Sheets at December 31, 2011 and 2010
Consolidated Statements of Operations for the years ended December 31, 2011, 2010, and 2009
Consolidated Statements of Shareholders' Equity and Comprehensive Income (Loss) for the years ended December 31, 2011, 2010, and 2009
Consolidated Statements of Cash Flows for the years ended December 31, 2011, 2010, and 2009
Notes to Consolidated Financial Statements
(2)
Financial Statement Schedules
All schedules are omitted because the required information is not present, is not present in amounts sufficient to require submission of the schedule, or because the required information is included in the financial statements or notes thereto.
(3)
Exhibits
The following exhibits are filed with this Annual Report on Form 10-K or are incorporated herein by reference:
Exhibit Number and Description
(2)
(a)
Agreement and Plan of Merger, dated as of April 7, 2009, by and among PulteGroup, Inc., Pi Nevada Building Company, and Centex Corporation (Incorporated by reference to Exhibit 2.1 of our Current Report on Form 8-K filed with the Securities and Exchange Commission (“SEC”) on April 10, 2009)
(3)
(a)
Restated Articles of Incorporation, of PulteGroup, Inc. (Incorporated by reference to Exhibit 3.1 of our Current Report on Form 8-K, filed with the SEC on August 18, 2009)
(b)
Certificate of Amendment to the Articles of Incorporation, dated March 18, 2010 (Incorporated by reference to Exhibit 3(b) of our Quarterly Report on Form 10-Q for the quarter ended March 31, 2010)
(c)
Certificate of Amendment to the Articles of Incorporation, dated May 21, 2010 (Incorporated by reference to Exhibit 3(c) of our Quarterly Report on Form 10-Q for the quarter ended September 30, 2010)
(d)
By-laws, as amended, of PulteGroup, Inc. (Incorporated by reference to Exhibit 3.1 of our Current Report on Form 8-K, filed with the SEC on April 8, 2009)
(e)
Certificate of Designation of Series A Junior Participating Preferred Shares, dated August 6, 2009 (Incorporated by reference to Exhibit 3(b) of our Registration Statement on Form 8-A, filed with the SEC on August 18, 2009)
(4)
(a)
Any instrument with respect to long-term debt, where the securities authorized thereunder do not exceed 10% of the total assets of PulteGroup, Inc. and its subsidiaries, has not been filed. The Company agrees to furnish a copy of such instruments to the SEC upon request.
(b)
Amended and Restated Section 382 Rights Agreement, dated as of March 18, 2010, between PulteGroup, Inc. and Computershare Trust Company, N.A., as rights agent, which includes the Form of Rights Certificate as Exhibit B thereto (Incorporated by reference to Exhibit 4 of PulteGroup, Inc.’s Registration Statement on Form 8-A/A filed with the SEC on March 23, 2010)
(10)
(a)
1994 Stock Incentive Plan for Key Employees (Incorporated by reference to our Proxy Statement dated March 31, 1994, and as Exhibit 4.1 of our Registration Statement on Form S-8, Registration No. 33-98944)
(b)
1995 Stock Incentive Plan for Key Employees (Incorporated by reference to our Proxy Statement dated March 31, 1995, and as Exhibit 4.1 of our Registration Statement on Form S-8, Registration No. 33-99218)
(c)
1997 Stock Plan for Nonemployee Directors (Incorporated by reference to our Proxy Statement dated March 27, 1998, and as Exhibit 4.3 of our Registration Statement on Form S-8, Registration No. 333-52047)
(d)
PulteGroup, Inc. 401(k) Plan (Incorporated by reference to Exhibit 4.3 of our Registration Statement on Form S-8, No. 333-115570)
(e)
Intercreditor and Subordination Agreement, dated October 1, 2003, among Asset Seven Corp., Pulte Realty Corporation, certain subsidiaries of PulteGroup, Inc., Bank One, NA, as Administrative Agent, and Bank One Trust Company, National Association, as Trustee (Incorporated by reference to Exhibit 10(f) to our Annual Report on Form 10-K for the year ended December 31, 2003)
(f)
Facility Agreement dated as of June 23, 2009 among PulteGroup, Inc., Various Financial Institutions, and Deutsche Bank AG, New York Branch (Incorporated by reference to Exhibit 10.1 of our Current Report on Form 8-K, filed with the SEC on June 26, 2009)
(g)
PulteGroup, Inc. 2000 Stock Incentive Plan for Key Employees (Incorporated by reference to Exhibit 4.3 of our Registration Statement on Form S-8, Registration No. 333-66284)
(h)
PulteGroup, Inc. 2000 Stock Plan for Nonemployee Directors (Incorporated by reference to Exhibit 4.3 of our Registration Statement on Form S-8, Registration No. 333-66284)
(i)
Form of Restricted Stock Award agreement under PulteGroup, Inc. 2000 Stock Incentive Plan for Key Employees (Incorporated by reference to Exhibit 10(l) of our Annual Report on Form 10-K for the year ended December 31, 2006)
(j)
Form of Restricted Stock Award agreement (as amended) under PulteGroup, Inc. 2000 Stock Incentive Plan for Key Employees (Incorporated by Reference to Exhibit 10(o) of our Annual Report on Form 10-K for the year ended December 31, 2008)
(k)
PulteGroup, Inc. 2002 Stock Incentive Plan (Incorporated by reference to our Proxy Statement dated April 3, 2002 and as Exhibit 4.3 of our Registration Statement on Form S-8, No. 333-123223)
(l)
PulteGroup, Inc. 2008 Senior Management Incentive Plan (Incorporated by reference to our Proxy Statement dated April 7, 2008)
(m)
PulteGroup, Inc. Long-Term Incentive Program (Incorporated by reference to Exhibit 10.2 of our Current Report on Form 8-K, filed with the SEC on May 20, 2008)
(n)
Form of PulteGroup, Inc. Long Term Incentive Award Agreement (Incorporated by reference to Exhibit 10.3 of our Current Report on Form 8-K, filed with the SEC on May 20, 2008)
(o)
Form of PulteGroup, Inc. 2008-2010 Grant Acceptance Agreement - Company Performance Measures (Incorporated by reference to Exhibit 10.4 of our Current Report on Form 8-K, filed with the SEC on May 20, 2008)
(p)
Form of PulteGroup, Inc. 2008-2010 Grant Acceptance Agreement - Individual Performance Measures (Incorporated by reference to Exhibit 10.5 of our Current Report on Form 8-K, filed with the SEC on May 20, 2008)
(q)
PulteGroup, Inc. 2004 Stock Incentive Plan (as Amended and Restated as of July 9, 2009) (Incorporated by reference to Exhibit 10(a) of our Quarterly Report on Form 10-Q for the quarter ended September 30, 2009)
(r)
Form of Restricted Stock Award Agreement (as amended) under PulteGroup, Inc. 2004 Stock Incentive Plan (Incorporated by reference to Exhibit 10(r) of our Annual Report on Form 10-K for the year ended December 31, 2007)
(s)
Form of Restricted Stock Award Agreement (as amended) under PulteGroup, Inc. 2004 Stock Incentive Plan (Incorporated by reference to Exhibit 10(a) of our Quarterly Report on Form 10-Q for the quarter ended March 31, 2010)
(t)
Form of Restricted Stock Award Agreement (as amended) under PulteGroup, Inc. 2000 Stock Incentive Plan for Key Employees ( Incorporated by reference to Exhibit 10(b) of our Quarterly Report on Form 10-Q for the quarter ended March 31, 2010)
(u)
Form of Stock Option Agreement under PulteGroup, Inc. 2002 and 2004 Stock Incentive Plans (Incorporated by reference to Exhibit 10(s) of our Annual Report on Form 10-K for the year ended December 31, 2007)
(v)
Form of Stock Option Agreement (as amended) under PulteGroup, Inc. 2002 and 2004 Stock Incentive Plans (Incorporated by reference to Exhibit 10(t) of our Annual Report on Form 10-K for the year ended December 31, 2007)
(w)
Form of Performance Share Award Agreement under PulteGroup, Inc. 2004 Stock Incentive Plan (Filed herewith)
(x)
Centex Corporation Amended and Restated 1987 Stock Option Plan (Amended and Restated Effective February 11, 2009) (Incorporated by reference to Exhibit 10.4 of Centex’s Current Report on Form 8-K, filed with the SEC on February 13, 2009)
(y)
Amended and Restated Centex Corporation 2001 Stock Plan (Amended and Restated Effective February 11, 2009) (Incorporated by reference to Exhibit 10.2 of Centex’s Current Report on Form 8-K, filed with the SEC on February 13, 2009)
(z)
Form of stock option agreement for the Amended and Restated Centex Corporation 2001 Stock Plan (Incorporated by reference to Exhibit 10.5 of Centex’s Current Report on Form 8-K, filed with the SEC on May 13, 2008)
(aa)
Centex Corporation 2003 Equity Incentive Plan (Amended and Restated Effective February 11, 2009) (Incorporated by reference to Exhibit 10.1 of Centex’s Current Report on Form 8-K, filed with the SEC on February 13, 2009)
(ab)
Form of stock option agreement for the Centex Corporation 2003 Equity Incentive Plan (Incorporated by reference to Exhibit 10.6 of Centex’s Current Report on Form 8-K, filed with the SEC on May 13, 2008)
(ac)
PulteGroup, Inc. Long Term Compensation Deferral Plan (As Amended and Restated Effective January 1, 2004) (Incorporated by reference to Exhibit 10(a) of our Quarterly Report on Form 10-Q for the quarter ended March 31, 2006)
(ad)
PulteGroup, Inc. Deferred Compensation Plan for Non-Employee Directors (as Amended and Restated Effective December 8, 2009) (Incorporated by reference to Exhibit 10(al) of our Annual Report on Form 10-K for the year ended December 31, 2009)
(ae)
Assignment and Assumption Agreement dated as of August 18, 2009 between PulteGroup, Inc. and Centex Corporation (Incorporated by reference to Exhibit 10.2 of our Current Report on Form 8-K, filed with the SEC on August 20, 2009)
(af)
Offer Letter to Deborah Meyer dated as of August 20, 2009 (Incorporated by reference to Exhibit 10(a) of our Quarterly Report on Form 10-Q for the quarter ended March 31, 2011)
(ag)
Clarification of Offer Letter to Deborah Meyer dated as of April 26, 2011 (Incorporated by reference to Exhibit 10(b) of our Quarterly Report on Form 10-Q for the quarter ended March 31, 2011)
(ah)
Separation Agreement dated as of May 26, 2011, between PulteGroup, Inc. and Roger A. Cregg (Incorporated by reference to Exhibit 10.1 of our Current Report on Form 8-K filed with the SEC on May 27, 2011)
(ai)
Offer Letter dated as of May 9, 2011, between PulteGroup, Inc. and Robert T. O'Shaughnessy (Incorporated by reference to Exhibit 10(a) of our Current Report on Form 8-K filed with the SEC on May 9, 2011)
(12)
Ratio of Earnings to Fixed Charges at December 31, 2011 (Filed herewith)
(21)
Subsidiaries of the Registrant (Filed herewith)
(23)
Consent of Independent Registered Public Accounting Firm (Filed herewith)
(31)
(a)
Rule 13a-14(a) Certification by Richard J. Dugas, Jr., Chairman, President, and Chief Executive Officer (Filed herewith)
(b)
Rule 13a-14(a) Certification by Robert T. O'Shaughnessy, Executive Vice President and Chief Financial Officer (Filed herewith)
(32)
Certification Pursuant to 18 United States Code § 1350 and Rule 13a-14(b) of the Securities Exchange Act of 1934 (Filed herewith)
101.INS
XBRL Instance Document
101.SCH
XBRL Taxonomy Extension Schema Document
101.CAL
XBRL Taxonomy Extension Calculation Linkbase Document
101.LAB
XBRL Taxonomy Extension Label Linkbase Document
101.PRE
XBRL Taxonomy Extension Presentation Linkbase Document
101.DEF
XBRL Taxonomy Extension Definition Linkbase Document
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
PULTEGROUP, INC.
(Registrant)
February 9, 2012
By:
/s/ Robert T. O'Shaughnessy
Robert T. O'Shaughnessy
Executive Vice President
and Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capabilities and on the dates indicated:
Signature
Title
Date
/s/ Richard J. Dugas, Jr.
Chairman of the Board of Directors, President, and Chief Executive Officer
(Principal Executive Officer)
February 9, 2012
Richard J. Dugas, Jr.
/s/ Robert T. O'Shaughnessy
Executive Vice President and
Chief Financial Officer
(Principal Financial Officer)
February 9, 2012
Robert T. O'Shaughnessy
/s/ Michael J. Schweninger
Vice President and Controller
(Principal Accounting Officer)
February 9, 2012
Michael J. Schweninger
/s/ Brian P. Anderson
Member of Board of Directors
February 9, 2012
Brian P. Anderson
/s/ Bryce Blair
Member of Board of Directors
February 9, 2012
Bryce Blair
/s/ Cheryl W. Grisé
Member of Board of Directors
February 9, 2012
Cheryl W. Grisé
/s/ Debra J. Kelly-Ennis
Member of Board of Directors
February 9, 2012
Debra J. Kelly-Ennis
/s/ David N. McCammon
Member of Board of Directors
February 9, 2012
David N. McCammon
/s/ Patrick J. O’Leary
Member of Board of Directors
February 9, 2012
Patrick J. O’Leary
/s/ James J. Postl
Member of Board of Directors
February 9, 2012
James J. Postl
/s/ Bernard W. Reznicek
Member of Board of Directors
February 9, 2012
Bernard W. Reznicek
/s/ Thomas M. Schoewe
Member of Board of Directors
February 9, 2012
Thomas M. Schoewe