PulteGroup, Inc. — 2018 Q3 Form 10-Q
Business context and period: U.S. homebuilder with mortgage, title, and insurance brokerage operations. This unaudited quarterly report covers the three and nine months ended September 30, 2018; comparisons are with the corresponding 2017 periods.
Financial performance and position
Unless noted otherwise, amounts are in millions of dollars.
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Total revenue | $2,649 | $2,131 | $7,189 | $5,783 |
| Income before tax | $385 | $268 | $1,018 | $530 |
| Net income | $290 | $178 | $784 | $370 |
| Diluted EPS | $1.01 | $0.58 | $2.71 | $1.18 |
| Home sale gross margin | 24.0% | 23.9% | 23.9% | 22.7% |
| SG&A as % of home sale revenue | 9.8% | 11.6% | 10.4% | 12.3% |
- Home sale revenue rose 25% in Q3 and 24% year to date. Closings increased 17% and 14%, respectively, while average selling prices rose 7% and 9%.
- Net cash from operating activities was $1,015 for the nine months, versus $252 in 2017. Cash at period end, including restricted cash, was $759, up from $306 at December 31, 2017. Operating cash flow included $784 of net income and was partly offset by a $264 inventory increase.
- Investing activities used $32; financing activities used $530, including $172 of share repurchases, $78 of dividends paid, and debt repayments. The comparable 2017 financing outflow was $739, including substantially larger share repurchases.
- At September 30, cash and equivalents were $729 and restricted cash was $30. Notes payable were $3,005, including $2,987 of senior notes; Financial Services debt was $251. The company had no revolver borrowings and $780 of unused capacity after letters of credit. Debt to capitalization, excluding Financial Services debt, was 38.9%.
- Senior notes mature from 2021 onward; $700 is due in 2021. The company reported compliance with its credit facility covenants.
Changes, outlook, and management commentary
- Revenue, pretax income, and earnings increased substantially year over year. Homebuilding pretax income rose 46% in Q3 and 101% year to date, reflecting higher revenue and better overhead leverage. Home sale gross margin improved year to date.
- Management cited economic growth, job and wage gains, low unemployment, and limited new-home supply as demand supports. It said the backlog and market conditions positioned the business for strong performance for the balance of 2018, but gave no quantified full-year guidance.
- Net new orders rose 1% in Q3 and 4% year to date in units; order dollars rose 1% and 7%. September backlog increased 3% in units to 11,164 homes and 5% in value to $4,911. The cancellation rate was 15% for Q3 and 13% year to date, unchanged from the comparable periods.
- Management reported that higher mortgage rates beginning in May were associated with weaker-than-expected traffic-to-signup conversion, especially among first-time and move-up buyers, despite increased traffic. It identified affordability pressure from higher home prices and mortgage rates as a near-term concern.
- Regional results were uneven: Florida and West revenue growth was strong, while West Q3 orders fell 13%, concentrated in Northern California; Q3 orders also declined in the Southeast and Midwest.
- The effective tax rate declined to 24.7% for Q3 and 23.0% year to date, from 33.8% and 30.2%, primarily reflecting the federal corporate tax rate reduction under the Tax Act. Tax accounting was not yet complete.
Unusual items, risks, and contingencies
- Year-to-date 2018 results included $28.9 of land-sale gains, including $26.4 from two California transactions, and $37.9 of general-liability insurance reserve reversals. These items boosted reported results; 2017 included $131.3 of land-related charges and a $12.3 warranty charge.
- The company recorded $727 of reserves for self-insured claims at September 30 and $151 of insurance receivables. Estimates depend on actuarial assumptions and recovery from insurers; a $21.5 insurance-receivable dispute was in arbitration. Management said actual costs and recoveries could differ materially from estimates.
- Other exposures include $34.4 of mortgage origination liability reserves, litigation and regulatory matters, $220 of letters of credit, and approximately $1.2 billion of surety bonds. Management did not expect a material adverse outcome from pending legal matters, but noted losses could exceed recorded reserves.
- Land option agreements carried $2.7 billion of remaining purchase price and $245 of deposits and pre-acquisition costs; the agreements generally may be canceled at the company’s discretion. Joint ventures had $49.5 of debt, with limited guarantees on a major venture.
- Principal risks identified include mortgage-rate increases and financing availability, affordability, land and construction costs, labor and insurance availability, housing-market conditions, regulatory and legal matters, and uncertainty in estimates for inventory impairments, warranties, and insurance claims.
- ASC 606 adoption increased opening retained earnings by $22.4, net of tax, primarily for estimated insurance-renewal commissions; management reported no material revenue impact for the nine-month period. The company expects lease accounting adoption in 2019 to materially affect the balance sheet, but not materially affect earnings or cash flows.
Important facts for investors to verify
- Whether higher mortgage rates and affordability constraints continue to weigh on order conversion, particularly among first-time and move-up buyers.
- Backlog conversion, cancellation trends, and regional order performance, especially in Northern California and other markets with softer orders.
- How much earnings growth reflects recurring homebuilding performance versus land-sale gains, insurance reserve reversals, tax-rate changes, and prior-year charges.
- The adequacy and sensitivity of self-insurance reserves and the collectability of insurance receivables, including the arbitration claim.
- Liquidity and debt levels as the company invests in inventory and land options, and its ability to meet obligations while continuing dividends and share repurchases.
- Potential effects of completing Tax Act accounting and implementing lease accounting in 2019.