PulteGroup, Inc. — Q1 2018 Form 10-Q
Business context and reporting period
Unaudited results cover the three months ended March 31, 2018, compared with the same 2017 period. PulteGroup is a U.S. homebuilder operating across six homebuilding segments, with mortgage, title and insurance brokerage businesses in Financial Services. At quarter-end, it operated in 45 markets across 25 states.
Financial and operating performance
- Revenue: $1.970 billion, up 21% year over year. Homebuilding revenue was $1.924 billion, up 21%; Financial Services revenue was $45.9 million, up 10%.
- Profit: Pretax income was $224.2 million versus $139.3 million; net income was $170.8 million versus $91.5 million. Diluted EPS was $0.59 versus $0.28. The effective tax rate fell to 23.8% from 34.3%, primarily reflecting the lower federal statutory rate under the Tax Act.
- Homebuilding margins and costs: Home-sale gross margin was 23.6%, up 40 basis points. SG&A was 12.6% of home-sale revenue versus 14.9%, reflecting volume and cost efficiencies and a prior-year insurance-related charge.
- Orders and backlog: Closings rose 9% to 4,626 homes; average selling price increased 10% to $413,000. Net new orders rose 12% in units and 18% in dollars; cancellation rate remained 12%. Backlog increased 21% to 11,245 homes and 30% to $4.961 billion.
- Cash flow: Operating cash flow was $169.0 million, up from $39.8 million. Inventory investment used $237.2 million, partly offset by a $185.1 million seasonal reduction in mortgage loans held for sale. Investing activities used $16.0 million; financing activities used $274.4 million. Cash, cash equivalents and restricted cash ended at $184.8 million.
- Liquidity and debt: Unrestricted cash was $150.8 million; restricted cash was $34.0 million. Notes payable totaled $3.088 billion, including $3.0 billion of senior notes; Financial Services debt was $247.0 million. No revolver borrowings were outstanding, and $773.7 million was available after letters of credit. Debt to total capitalization, excluding Financial Services debt, was 41.9%. The company reported covenant compliance.
- Capital returns: The company declared $26.1 million in dividends and repurchased 1.7 million shares for $52.5 million during the quarter; $542.0 million remained authorized for repurchases.
Material changes and management commentary
- Management cited improving housing demand, supported by employment, consumer confidence and demographics, as well as limited housing supply. It attributed revenue growth to higher closings and selling prices, and said investments supported more active communities.
- Homebuilding pretax income rose 67%, driven by higher revenue, improved gross margins and overhead leverage. The prior-year period included a $15.0 million insurance-receivable write-off. Financial Services pretax income increased 2%; higher origination volume was largely offset by expenses and competitive pricing.
- West segment revenue and pretax income rose sharply, partly because a Northern California multifamily project had delayed closings in late 2017 and unusually high selling prices and margins. Texas closings fell 4%; Midwest net new orders fell 5%, partly reflecting the St. Louis market exit.
- ASC 606 was adopted January 1, 2018, increasing opening retained earnings by $22.4 million, net of tax, primarily for estimated insurance-brokerage renewal commissions. Adoption had no material revenue impact in the quarter. The company expected the new lease standard, effective in 2019, to materially affect balance-sheet presentation but not to materially affect operating results.
- Management expressed confidence in strong performance throughout 2018 and ongoing shareholder returns, but provided no specific numerical revenue, earnings or margin guidance in the filing.
Risks, contingencies and unusual items
- Homebuilder risks include higher mortgage rates, inflation and construction costs, labor availability, land costs, weather, regulation and weaker local or national housing demand. Management warned that inability to pass on cost increases, or significant rate increases, could hurt revenue, margins and earnings.
- Self-insured and other insurance-related reserves were $771.1 million at quarter-end, largely for general liability claims; estimates depend on long-tailed claims and actuarial assumptions. Insurance receivables were $217.1 million, including $70.1 million subject to litigation with carriers. Management believed collection was probable but outcomes are uncertain.
- Outstanding letters of credit were $226.3 million and surety bonds approximately $1.2 billion. Land-option agreements carried $2.3 billion of remaining purchase commitments, with $210.9 million in deposits and pre-acquisition costs. Joint-venture debt was $57.8 million; the company’s stated exposure on the principal guaranteed venture was limited to its pro rata share.
- The mortgage repurchase agreement matured in August 2018; the revolving credit facility matured in June 2019. The company also disclosed that Tax Act accounting was not complete and that tax estimates and deferred tax asset realizability depend on future results.
Important facts for investors to verify
- Whether order and backlog growth converts to closings at expected prices and margins, particularly given the unusually strong Northern California multifamily contribution.
- Whether construction-cost inflation, labor constraints and mortgage-rate changes affect affordability, cancellations and gross margins.
- The adequacy of the $771.1 million insurance reserve and recoverability of disputed insurance receivables, including the $70.1 million in litigation.
- Liquidity and refinancing arrangements around the August 2018 mortgage repurchase agreement and June 2019 revolving facility maturities.
- How much of operating cash flow reflects seasonal mortgage-loan movements versus sustainable earnings, and the ongoing cash needs of inventory investment and shareholder returns.
- Completion of Tax Act accounting and the eventual balance-sheet effect of adopting the lease standard.