PulteGroup, Inc. — Q2 2011 Form 10-Q
Business context and reporting period. PulteGroup is a U.S. homebuilder with mortgage and title operations. This unaudited filing covers the three and six months ended June 30, 2011; comparisons are with the corresponding 2010 periods unless noted. Dollar amounts below are in millions unless stated otherwise.
Financial performance and position
- Revenue: Q2 total revenue was $927.2, down 29% from $1,305.9; first-half revenue was $1,732.4, down 26% from $2,326.3. Home sale revenue fell 29% in Q2 and 25% in the first half, reflecting fewer settlements and slightly lower average selling prices.
- Profit and margins: Q2 net loss was $55.4, or $0.15 per diluted share, versus net income of $76.3, or $0.20 per share. First-half net loss was $94.9, or $0.25 per share, versus net income of $63.8, or $0.17 per share. Home sale gross margin was 12.2% in Q2 and 12.3% for the first half, compared with 12.6% and 12.7%. Excluding specified land valuation adjustments, capitalized-interest amortization, and merger costs, management reported adjusted gross margins of 17.2% and 17.1%, respectively; these are non-GAAP measures.
- Cash flow: First-half operating cash outflow was $220.2, versus inflow of $850.1 in 2010. The 2011 outflow included a $181.0 inventory increase and a net loss; 2010 cash flow benefited from $890.1 of net tax refunds. Investing activities used $104.4, including $103.9 placed in restricted cash for letter-of-credit collateral. Financing activities used $70.8, principally for debt repayments. Cash and equivalents declined to $1,075.2 from $1,470.6 at year-end.
- Debt and liquidity: Senior notes were $3,332.3 at June 30, down from $3,391.7 at year-end; estimated fair value was $3,244.7. The company retired $53.0 of notes before maturity and incurred a $3.5 loss. Restricted cash was $128.2. Debt to total capitalization, excluding land-collateralized debt, was 61.9%, or 50.9% net of cash and restricted cash. The company reported $1.0 of limited-recourse land-collateralized financing.
- Homebuilding indicators: Q2 settlements were 3,633 units, down 28%; average selling price was $248,000, down 1%. Net new orders were 4,222 units, essentially flat; cancellations were 19% versus 18%. Backlog was 5,777 units worth $1,583.5, up 2% in units year over year. Active communities declined 5% to 797.
- Other key metrics: Financial Services revenue fell 38% in Q2 and 34% in the first half; the segment recorded pretax losses of $16.6 and $15.7, respectively. Total assets were $7,425.6 and shareholders’ equity $2,049.7 at June 30. No dividends were declared.
Material changes versus the prior comparable period
- Homebuilding pretax results shifted to a $27.8 Q2 loss from $11.8 income, and to a $68.6 first-half loss from approximately break-even. Lower settlements and revenue outweighed reduced SG&A.
- Financial Services losses widened, largely due to provisions for mortgage-loan repurchase liabilities and lower origination volumes. The first-half provision for these liabilities was $19.3, compared with $16.9 in 2010.
- Homebuilding land and community valuation adjustments fell to $3.3 in Q2 and $3.4 for the first half, from $25.5 and $30.1. Management attributed the lower charges to relative market stability.
- Cash generation weakened sharply year over year, partly because prior-year operating cash flow included substantial tax refunds and 2011 inventory investment increased.
- The company reduced Homebuilding reporting areas from four to three in Q2 and continued restructuring and cost reductions.
Outlook, risks, contingencies, and unusual items
- Outlook: Management did not provide quantified full-year guidance and said a broad 2011 housing recovery was not expected. It believed improved gross margins, higher volumes, and overhead leverage could support profitability in the second half, while emphasizing limited earnings visibility and a cautious outlook.
- Market risks: Management cited weak employment and consumer confidence, foreclosure activity, mortgage-rate and lending-standard changes, affordability, economic uncertainty, and possible regulatory or mortgage-finance reforms. Local market volatility and the availability and cost of land, labor, materials, and insurance also pose risks.
- Asset valuation: Further deterioration in housing or local markets, or changes in community plans, could require additional inventory impairments. Of $240.5 of goodwill, $228.0 was associated with reporting units identified as at increased risk of future impairment.
- Mortgage claims: The loan-origination liability was $97.8 at June 30. Claims largely concern 2006–2007 originations; management said future losses could exceed estimates and assumed claim volumes would not return to pre-2009 levels until after 2012.
- Insurance and warranty exposure: Recorded insurance reserves were $790.6, substantially related to general liability claims; approximately 77% of the general liability reserve covered incurred-but-not-reported claims. Warranty liabilities were $70.5. Estimates are uncertain and actual costs may differ.
- Other contingencies: Outstanding letters of credit and surety bonds totaled $1.6 billion. Accrued community development district obligations were $42.3. The company reported ordinary-course litigation and regulatory matters, while stating it did not expect their resolution to have a material adverse effect; additional charges remain possible.
- Unusual items and liquidity actions: Q2 included $11.9 of restructuring charges, including severance and lease exits. The company terminated its unused $250 revolving credit facility, releasing its $250 liquidity reserve and related covenants, and replaced letter-of-credit capacity partly with cash-collateralized arrangements. The change contributed to restricted cash. A $5.2 discount on repurchased community development obligations will reduce cost of revenues over the related communities’ lives.
- Taxes: The company had $2.6 billion of net deferred tax assets fully offset by a valuation allowance. It also reported $248.5 of gross unrecognized tax benefits and $50.4 of accrued penalties and interest; up to $106.9 of unrecognized tax benefits, excluding interest and penalties, could decrease within twelve months, though outcomes were uncertain.
Important facts for investors to verify
- Whether order trends, backlog conversion, settlements, average prices, and cancellations support management’s second-half profitability expectation.
- Whether homebuilding gross margins and overhead costs improve as projected, particularly after restructuring and as capitalized interest is recognized in home costs.
- Whether operating cash use, inventory investment, restricted-cash requirements, and debt maturities remain manageable given cash of $1.1 billion and senior notes of $3.3 billion.
- Whether mortgage repurchase claims and general liability insurance reserves are adequate, and how actual settlements compare with management’s estimates.
- Whether housing-market weakness triggers further inventory or goodwill impairments, and whether deferred tax assets or uncertain tax positions change materially.