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EX-32 - CERTIFICATION - PULTEGROUP INC/MI/dex32.htm
EX-10.(A) - OFFER LETTER TO DEBORAH MEYER, DATED AUGUST 20, 2009 - PULTEGROUP INC/MI/dex10a.htm
EX-31.(A) - CERTIFICATION - PULTEGROUP INC/MI/dex31a.htm
EX-31.(B) - CERTIFICATION - PULTEGROUP INC/MI/dex31b.htm
EXCEL - IDEA: XBRL DOCUMENT - PULTEGROUP INC/MI/Financial_Report.xls
EX-10.(B) - CLARIFICATION OF OFFER LETTER TO DEBORAH MEYER, DATED APRIL 25, 2011 - PULTEGROUP INC/MI/dex10b.htm
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2011

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number 1-9804

 

 

PULTEGROUP, INC.

(Exact name of registrant as specified in its charter)

 

 

 

 

MICHIGAN   38-2766606

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

100 Bloomfield Hills Parkway, Suite 300

Bloomfield Hills, Michigan 48304

(Address of principal executive offices) (Zip Code)

Registrant’s telephone number, including area code (248) 647-2750

 

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    YES  þ    NO  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    YES  þ    NO  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer  þ    Accelerated filer  ¨    Non-accelerated filer  ¨    Smaller reporting company  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). YES    ¨  NO    þ

Number of shares of common stock outstanding as of April 22, 2011: 382,811,979

 

 

 


Table of Contents

PULTEGROUP, INC.

INDEX

 

          Page No.  
PART I    FINANCIAL INFORMATION   

Item 1

  

Financial Statements

  
  

Condensed Consolidated Balance Sheets at March 31, 2011 and December 31, 2010

     3   
  

Consolidated Statements of Operations for the three months ended March 31, 2011 and 2010

     4   
  

Consolidated Statements of Shareholders’ Equity for the three months ended March 31, 2011 and 2010

     5   
  

Consolidated Statements of Cash Flows for the three months ended March 31, 2011 and 2010

     6   
  

Notes to Condensed Consolidated Financial Statements

     7   

Item 2

   Management’s Discussion and Analysis of Financial Condition and Results of Operations      34   

Item 3

   Quantitative and Qualitative Disclosures About Market Risk      48   

Item 4

   Controls and Procedures      50   

PART II

   OTHER INFORMATION   

Item 2

   Unregistered Sales of Equity Securities and Use of Proceeds      50   

Item 6

   Exhibits      51   

SIGNATURES

        52   

 

2


Table of Contents

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements

PULTEGROUP, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

($000’s omitted)

 

     March 31,
2011
     December 31,
2010
 
     (Unaudited)      (Note)  
ASSETS      

Cash and equivalents

   $ 1,292,949       $ 1,470,625   

Restricted cash

     133,404         24,601   

Unfunded settlements

     12,473         12,765   

House and land inventory

     4,767,216         4,781,813   

Land held for sale

     96,690         71,055   

Land, not owned, under option agreements

     43,271         50,781   

Residential mortgage loans available-for-sale

     143,846         176,164   

Investments in unconsolidated entities

     45,470         46,313   

Goodwill

     240,541         240,541   

Intangible assets, net

     172,173         175,448   

Other assets

     489,147         567,963   

Income taxes receivable

     79,449         81,307   
                 
   $ 7,516,629       $ 7,699,376   
                 
LIABILITIES AND SHAREHOLDERS’ EQUITY      

Liabilities:

     

Accounts payable, including book overdrafts of $28,424 and $63,594 in 2011 and 2010, respectively

   $ 206,067       $ 226,466   

Customer deposits

     66,422         51,727   

Accrued and other liabilities

     1,473,415         1,599,940   

Income tax liabilities

     289,605         294,408   

Senior notes

     3,380,980         3,391,668   
                 

Total liabilities

     5,416,489         5,564,209   

Shareholders’ equity

     2,100,140         2,135,167   
                 
   $ 7,516,629       $ 7,699,376   
                 

Note: The Condensed Consolidated Balance Sheet at December 31, 2010 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements.

See accompanying Notes to Condensed Consolidated Financial Statements.

 

3


Table of Contents

PULTEGROUP, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(000’s omitted, except per share data)

(Unaudited)

 

     Three Months Ended
March 31,
 
     2011     2010  

Revenues:

    

Homebuilding

    

Home sale revenues

   $ 782,471      $ 976,806   

Land sale revenues

     1,296        12,986   
                
     783,767        989,792   

Financial Services

     21,435        30,566   
                

Total revenues

     805,202        1,020,358   
                

Homebuilding Cost of Revenues:

    

Home sale cost of revenues

     685,030        850,095   

Land sale cost of revenues

     930        8,998   
                
     685,960        859,093   

Financial Services expenses

     20,473        25,111   

Selling, general, and administrative expenses

     142,446        161,306   

Other expense (income), net

     3,910        (8,441

Interest income

     (1,437     (2,779

Interest expense

     351        482   

Equity in (earnings) loss from unconsolidated entities

     (1,109     94   
                

Income (loss) before income taxes

     (45,392     (14,508

Income tax expense (benefit)

     (5,866     (2,020
                

Net income (loss)

   $ (39,526   $ (12,488
                

Per share data:

    

Net loss:

    

Basic

   $ (0.10   $ (0.03
                

Diluted

   $ (0.10   $ (0.03
                

Cash dividends declared

   $ —        $ —     
                

Number of shares used in calculation:

    

Basic

     379,544        377,747   
                

Diluted

     379,544        377,747   
                

See accompanying Notes to Condensed Consolidated Financial Statements.

 

4


Table of Contents

PULTEGROUP, INC.

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

(000’s omitted)

(Unaudited)

 

     Common Stock     Additional
Paid-in
    Accumulated
Other
Comprehensive
Income
    Retained
Earnings
(Accumulated
    Total
Shareholders’
 
     Shares     $     Capital     (Loss)     Deficit)     Equity  

Shareholders’ Equity, January 1, 2011

     382,028      $ 3,820      $ 2,972,919      $ (1,519   $ (840,053   $ 2,135,167   

Stock awards, net of cancellations

     910        9        (9     —          —          —     

Stock repurchases

     (129     (1     (1,002     —          34        (969

Stock-based compensation

     —          —          5,510        —          —          5,510   

Comprehensive income (loss):

            

Net income (loss)

     —          —          —          —          (39,526     (39,526

Change in fair value of derivatives, net of tax

     —          —          —          9        —          9   

Foreign currency translation adjustments

     —          —          —          (51     —          (51
                  

Total comprehensive income (loss)

     —          —          —          —          —          (39,568
                                                

Shareholders’ Equity, March 31, 2011

     382,809      $ 3,828      $ 2,977,418      $ (1,561   $ (879,545   $ 2,100,140   
                                                

Shareholders’ Equity, January 1, 2010

     380,690      $ 3,807      $ 2,935,737      $ (2,249   $ 257,145      $ 3,194,440   

Stock option exercises

     835        8        8,081        —          —          8,089   

Stock awards, net of cancellations

     1,177        12        (12     —          —          —     

Stock repurchases

     (155     (2     (1,194     —          (501     (1,697

Stock-based compensation

     —          —          8,109        —          —          8,109   

Comprehensive income (loss):

            

Net income (loss)

     —          —          —          —          (12,488     (12,488

Change in fair value of derivatives, net of tax

     —          —          —          84        —          84   

Foreign currency translation adjustments

     —          —          —          18        —          18   
                  

Total comprehensive income (loss)

     —          —          —          —          —          (12,386
                                                

Shareholders’ Equity, March 31, 2010

     382,547      $ 3,825      $ 2,950,721      $ (2,147   $ 244,156      $ 3,196,555   
                                                

See accompanying Notes to Condensed Consolidated Financial Statements.

 

5


Table of Contents

PULTEGROUP, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

($000’s omitted)

(Unaudited)

 

     For The Three Months Ended
March 31,
 
     2011     2010  

Cash flows from operating activities:

    

Net income (loss)

   $ (39,526   $ (12,488

Adjustments to reconcile net loss to net cash flows provided (used) by operating activities:

    

Write-down of land and deposits and pre-acquisition costs

     726        5,644   

Amortization and depreciation

     8,970        12,886   

Stock-based compensation expense

     5,510        8,109   

Equity in (earnings) loss from unconsolidated entities

     (1,109     94   

Distributions of earnings from unconsolidated entities

     411        —     

Other, net

     781        1,942   

Increase (decrease) in cash due to:

    

Restricted cash

     (108,803     1,699   

Inventories

     (11,245     (100,455

Residential mortgage loans available-for-sale

     32,292        8,135   

Income taxes receivable

     1,858        764,011   

Other assets

     78,747        66,864   

Accounts payable, accrued and other liabilities

     (122,825     (99,073

Income tax liabilities

     (4,803     20,199   
                

Net cash provided by (used in) operating activities

     (159,016     677,567   
                

Cash flows from investing activities:

    

Distributions from unconsolidated entities

     1,021        2,842   

Investments in unconsolidated entities

     (1,968     (1,217

Net change in loans held for investment

     255        563   

Proceeds from the sale of fixed assets

     2,441        476   

Capital expenditures

     (6,128     (3,325
                

Net cash provided by (used in) investing activities

     (4,379     (661
                

Cash flows from financing activities:

    

Net repayments (borrowings) under Financial Services credit arrangements

     —          40,250   

Repayments of other borrowings

     (13,312     (130

Issuance of common stock

     —          8,089   

Stock repurchases

     (969     (1,697
                

Net cash provided by (used in) financing activities

     (14,281     46,512   
                

Net increase (decrease) in cash and equivalents

     (177,676     723,418   

Cash and equivalents at beginning of period

     1,470,625        1,858,234   
                

Cash and equivalents at end of period

   $ 1,292,949      $ 2,581,652   
                

Supplemental Cash Flow Information:

    

Interest paid (capitalized), net

   $ (23,833   $ (10,987
                

Income taxes paid (refunded), net

   $ (2,922   $ (786,230
                

See accompanying Notes to Condensed Consolidated Financial Statements.

 

6


Table of Contents

PULTEGROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

1. Basis of presentation and significant accounting policies

Basis of presentation

PulteGroup, Inc. (“PulteGroup”) is a publicly-held holding company traded on the New York Stock Exchange under the ticker symbol “PHM”. The consolidated financial statements include the accounts of PulteGroup and all of its direct and indirect subsidiaries (collectively, the “Company”) and variable interest entities in which the Company is deemed to be the primary beneficiary. While the Company’s subsidiaries engage primarily in the homebuilding business, the Company also has mortgage banking operations, conducted principally through Pulte Mortgage LLC (“Pulte Mortgage”), and title operations.

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with United States generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by United States generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal, recurring adjustments) considered necessary for a fair presentation have been included. Operating results for the interim periods presented are not necessarily indicative of the results that may be expected for the full year. These financial statements should be read in conjunction with the Company’s consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010.

Use of estimates

The preparation of financial statements in conformity with United States 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.

Reclassifications

Certain prior period amounts have been reclassified to conform to the current year presentation.

Subsequent events

The Company evaluated subsequent events up until the time the financial statements were filed with the Securities and Exchange Commission.

Other expense (income), net

Other expense (income), net as reflected in the Consolidated Statements of Operations consists of the following (000’s omitted):

 

     Three Months Ended  
     March 31,  
     2011     2010  

Write-off of deposits and pre-acquisition costs

   $ 623      $ 543   

Lease exit and related costs (a)

     (82     1,355   

Amortization of intangible assets

     3,275        3,275   

Customer deposit income

     (717     (672

Miscellaneous expense (income), net

     811        (12,942
                
   $ 3,910      $ (8,441
                

 

(a) Excludes lease exit and related costs classified within Financial Services expense.

 

7


Table of Contents

PULTEGROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

 

 

1. Basis of presentation and significant accounting policies (continued)

 

Restricted cash

The Company maintains 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 10). The remaining balances relate to customer deposits on home sales which are temporarily restricted by regulatory requirements until title transfers to the homebuyer as well as certain other accounts with restrictions.

Notes receivable

In certain instances, the Company 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 strategic investors. The Company considers 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, the Company actively monitors each individual receivable separately and assesses 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 when it becomes likely that some amount will not be collectible and are reported net of allowance for credit losses within other assets in the Consolidated Balance Sheet. 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 the Company’s notes receivable and related allowance for credit losses at March 31, 2011 and December 31, 2010 ($000’s omitted):

 

     March 31,     December 31,  
     2011     2010  

Notes receivable, gross

   $ 72,655      $ 77,853   

Allowance for credit losses

     (21,062     (20,877
                

Notes receivable, net

   $ 51,593      $ 56,976   
                

The Company also records 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 in the Consolidated Balance Sheet. See Residential mortgage loans available-for-sale in Note 1 for discussion of the Company’s receivables related to mortgage operations.

Earnings per share

Basic earnings per share is computed by dividing income (loss) available to common shareholders (the “numerator”) by the weighted-average number of common shares, adjusted for non-vested shares of restricted stock (the “denominator”) for the period. Computing diluted earnings per share is similar to computing basic earnings per share, except that the denominator is increased to include the dilutive effects of options and non-vested shares of restricted stock. Any options that have an exercise price greater than the average market price are considered to be anti-dilutive and are excluded from the diluted earnings per share calculation. For the three months ended March 31, 2011 and 2010, all stock options and non-vested restricted stock were excluded from the calculation as they were anti-dilutive due to the net loss recorded during the periods.

Unvested share-based payment awards that contain non-forfeitable rights to dividends or dividend equivalents are participating securities and, therefore, are included in computing earnings per share pursuant to the two-class method. The two-class method determines earnings per share for each class of common stock and participating securities according to dividends or dividend equivalents and their respective participation rights in undistributed earnings. Although the Company’s outstanding restricted stock and restricted stock units are considered participating securities, there were no earnings attributable to restricted shareholders during the three months ended March 31, 2011 or 2010.

 

8


Table of Contents

PULTEGROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

 

 

1. Basis of presentation and significant accounting policies (continued)

 

Land, not owned, under option agreements

In the ordinary course of business, the Company enters into land option agreements in order to procure land for the construction of homes in the future. Pursuant to these land option agreements, the Company generally provides a deposit to the seller as consideration for the right to purchase land at different times in the future, usually at predetermined prices. Under Accounting Standards Codification (“ASC”) 810, “Consolidation” (“ASC 810”), if the entity holding the land under option is a variable interest entity (“VIE”), the Company’s deposit represents a variable interest in that entity. If the Company is determined to be the primary beneficiary of the VIE, then the Company is required to consolidate the VIE.

In applying the provisions of ASC 810, the Company evaluates all land option agreements with VIEs to determine whether the Company is the primary beneficiary. The Company generally has little control or influence over the operations of these VIEs due to the Company’s lack of an equity interest in them. Therefore, when the Company’s requests for financial information are denied, the Company is required to make certain assumptions about the assets, liabilities, and financing of such entities. The VIE is generally protected from the first dollar of loss under the Company’s land option agreement due to the Company’s deposit. Likewise, the VIE’s gains are generally capped based on the purchase price within the land option agreement. Additionally, creditors of the VIE have no recourse against the Company, and the Company does not provide financial or other support to these VIEs other than as stipulated in the land option agreements. The Company’s maximum exposure to loss related to these VIEs is generally limited to the Company’s deposits and pre-acquisition costs under the applicable land option agreements. In recent years, the Company has canceled a significant number of land option agreements, which has resulted in significant write-offs of the related deposits and pre-acquisition costs but has not exposed the Company to the overall risks or losses of the applicable VIEs. No VIEs required consolidation under ASC 810 at either March 31, 2011 or December 31, 2010.

Additionally, the Company determined that certain land option agreements represent financing arrangements pursuant to ASC 470-40, “Accounting for Product Financing Arrangements” (“ASC 470-40”), even though the Company has no direct obligation to pay these future amounts. As a result, the Company recorded $43.3 million and $50.8 million at March 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 the Company exercises the purchase rights under the agreements.

The following provides a summary of the Company’s interests in land option agreements as of March 31, 2011 and December 31, 2010 ($000’s omitted):

 

     March 31, 2011             December 31, 2010         
     Deposits
and Pre-
acquisition
Costs
     Total
Purchase
Price
     Land, Not
Owned,
Under
Option
Agreements
            Deposits
and Pre-
acquisition
Costs
     Total
Purchase
Price
     Land, Not
Owned,
Under
Option
Agreements
        

Consolidated VIEs

   $ 36,651       $ 40,732       $ 32,188         (a)       $ 41,813       $ 51,773       $ 42,401         (a)   

Unconsolidated VIEs

     27,165         305,061         —              10,280         202,214         —        

Other land option agreements

     27,522         355,049         11,083         (b)         42,970         455,481         8,380         (b)   
                                                           
   $ 91,338       $ 700,842       $ 43,271          $ 95,063       $ 709,468       $ 50,781      
                                                           

 

(a) Represents the remaining purchase price for land option agreements consolidated pursuant to ASC 810 or ASC 470-40 under which the land seller is considered a variable interest entity.
(b) Represents the remaining purchase price for land option agreements consolidated pursuant to ASC 470-40 under which the land seller is not considered a variable interest entity.

The above summary includes land option agreements consolidated under either ASC 810 or ASC 470-40 as well as all other land option agreements. The remaining purchase price (total purchase price less deposit) of all land option agreements totaled $654.3 million at March 31, 2011 and $670.5 million at December 31, 2010.

 

9


Table of Contents

PULTEGROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

 

 

1. Basis of presentation and significant accounting policies (continued)

 

Allowance for warranties

Home purchasers are provided with a limited warranty against certain building defects, including a one-year comprehensive limited warranty as well as coverage for certain other aspects of the home’s construction and operating systems for periods of up to ten years. The Company estimates the costs to be incurred under these warranties and records a liability in the amount of such costs at the time product revenue is recognized. Factors that affect the Company’s warranty liability include the number of homes sold, historical and anticipated rates of warranty claims, and the cost per claim. The Company periodically assesses the adequacy of its recorded warranty liability for each geographic market in which the Company operates and adjusts the amounts as necessary. Actual warranty costs in the future could differ from the current estimates. Changes to the Company’s warranty liability were as follows ($000’s omitted):

 

     Three Months Ended  
     March 31,  
     2011     2010  

Warranty liability, beginning of period

   $ 80,195      $ 96,110   

Warranty reserves provided

     9,089        10,139   

Payments

     (14,007     (18,110

Other adjustments

     (623     628   
                

Warranty liability, end of period

   $ 74,654      $ 88,767   
                

Residential mortgage loans available-for-sale

Substantially all of the loans originated by the Company are sold in the secondary mortgage market within a short period of time after origination. In accordance with ASC 825, “Financial Instruments,” the Company has elected the fair value option for its portfolio loans available-for-sale. Election of the fair value option for residential mortgage loans available-for-sale allows a better offset of the changes in fair values of the loans and the derivative instruments used to economically hedge them without having to apply complex hedge accounting provisions. The Company does not designate any derivative instruments or apply the hedge accounting provisions of ASC 815, “Derivatives and Hedging.” Fair values for conventional agency residential mortgage loans available-for-sale are determined based on quoted market prices for comparable instruments. Fair values for government and non-agency residential mortgage loans available-for-sale are determined based on purchase commitments from whole loan investors and other relevant market information available to management. At March 31, 2011 and December 31, 2010, residential mortgage loans available-for-sale had an aggregate fair value of $143.8 million and $176.2 million, respectively, and an aggregate outstanding principal balance of $139.5 million and $175.9 million, respectively. The net gain resulting from changes in fair value of these loans totaled $0.5 million for both the three months ended March 31, 2011 and 2010, and was included in Financial Services revenues. These changes in fair value were mostly offset by changes in fair value of the corresponding hedging instruments. Net gains from the sale of mortgages were $12.8 million and $14.8 million during the three months ended March 31, 2011 and 2010, respectively, and have been included in Financial Services revenues.

Mortgage servicing rights

The Company sells its servicing rights monthly on a flow basis through fixed price servicing contracts. In accordance with Staff Accounting Bulletin No. 109, the Company recognizes the fair value of its rights to service a mortgage loan as revenue at the time of entering into an interest rate lock commitment with a borrower. Due to the short period of time the servicing rights are held, the Company does not amortize the servicing asset. The servicing sales contracts provide for the reimbursement of payments made by the purchaser if loans prepay within specified periods of time, generally within 90 to 120 days after sale. The Company establishes reserves for this liability at the time the sale is recorded. Such reserves totaled $0.4 million and $0.5 million at March 31, 2011 and December 31, 2010, respectively, and are included in accrued and other liabilities. Servicing rights recognized in Financial Services revenues totaled $4.9 million and $6.7 million during the three months ended March 31, 2011 and 2010, respectively.

 

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PULTEGROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

 

 

1. Basis of presentation and significant accounting policies (continued)

 

Derivative instruments and hedging activities

The Company is exposed to market risks from commitments to lend, movements in interest rates, and cancelled or modified commitments to lend. A commitment to lend at a specific interest rate (an interest rate lock commitment) is a derivative financial instrument (interest rate is locked to the borrower). In order to reduce these risks, the Company uses other derivative financial instruments to economically hedge the interest rate lock commitment. These financial instruments include forward contracts on mortgage-backed securities and whole loan investor commitments. The Company does not use any derivative financial instruments for trading purposes. The Company enters into one of the aforementioned derivative financial instruments upon accepting interest rate lock commitments. Changes in the fair value of the interest rate lock commitment and the other derivative financial instruments are recognized in current period earnings and the fair value is reflected in other assets or other liabilities. The gains and losses are included in Financial Services revenues.

Fair values for interest rate lock commitments, including the value of servicing rights, are based on market prices for similar instruments. At March 31, 2011 and December 31, 2010, the Company had interest rate lock commitments in the amount of $139.6 million and $99.0 million, respectively, which were originated at interest rates prevailing at the date of commitment. Because the Company can terminate a loan commitment if the borrower does not comply with the terms of the contract, and some loan commitments may expire without being drawn upon, these commitments do not necessarily represent future cash requirements of the Company. The Company evaluates the creditworthiness of these transactions through its normal credit policies.

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 the Company extends 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 March 31, 2011, the Company had unexpired forward contracts and whole loan investor commitments of $217.7 million and $28.7 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 the Company’s derivative agreements. Gains and losses on interest rate lock commitments are offset by corresponding gains or losses on forward contracts on mortgage-backed securities and whole loan investor commitments. At March 31, 2011, the maximum length of time that the Company was exposed to the variability in future cash flows of derivative instruments was approximately 75 days.

The fair value of the Company’s derivative instruments and their location in the Consolidated Balance Sheet is summarized below ($000’s omitted):

 

     March 31, 2011      December 31, 2010  
     Other Assets      Other Liabilities      Other Assets      Other Liabilities  

Interest rate lock commitments

   $ 4,072       $ 72       $ 2,756       $ 64   

Forward contracts

     332         1,014         4,217         673   

Whole loan commitments

     887         6         2,319         —     
                                   
   $ 5,291       $ 1,092       $ 9,292       $ 737   
                                   

 

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PULTEGROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

 

2. 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. Recorded goodwill has been allocated to the Company’s reporting units based on the relative fair value of each acquired reporting unit. Management evaluates the recoverability of goodwill by comparing the carrying value of the Company’s reporting units to their fair value. Fair value is determined using accepted valuation methods, including the use of discounted cash flows supplemented by market-based assessments of fair value. Impairment is measured as the difference between the resulting implied fair value of goodwill and its recorded carrying value. The determination of fair value is significantly impacted by estimates related to current market valuations, current and future economic conditions in each of the Company’s geographical markets, and the Company’s strategic plans within each of its markets. Due to uncertainties in the estimation process and significant volatility in demand for new housing, actual results could differ significantly from such estimates.

The Company recorded $1.5 billion of goodwill in connection with the merger with Centex Corporation (“Centex”), which was completed in August 2009. All goodwill associated with prior transactions has been previously written-off. Since the Centex merger, the Company has recorded impairments of the majority of the associated goodwill, most recently in the third quarter of 2010. These impairments have resulted from a variety of factors, including, among other things, deteriorations in market conditions, the Company’s operating results falling below previously forecasted levels, and a sustained decline in the Company’s market capitalization since the Centex merger.

If management’s expectations of future results and cash flows for any of its reporting units decrease, goodwill may be further impaired. Also, while not directly triggering an impairment of goodwill, a significant decrease in the Company’s market capitalization in the future may indicate that the fair value of one or more of the Company’s reporting units has decreased, which may result in an impairment of goodwill. Of the Company’s remaining goodwill of $240.5 million at March 31, 2011, $228.0 million relates to reporting units that are at increased risk of future impairment. Management will continue to monitor these reporting units and perform goodwill impairment testing when events or changes in circumstances indicate the carrying amount may not be recoverable.

 

3. Restructuring

The Company has taken a series of actions in recent years both in response to the challenging operating environment and in connection with the Centex merger that were designed to reduce ongoing operating costs and improve operating efficiencies. As a result of the combination of these actions, the Company incurred total restructuring charges as summarized below ($000’s omitted):

 

     Three Months Ended  
     March 31,  
     2011     2010  

Employee severance benefits

   $ 3,031      $ 3,393   

Lease exit costs

     (51     786   

Other

     (3     569   
                

Total restructuring charges

   $ 2,977      $ 4,748   
                

Other than $0.5 million of total restructuring costs classified within Financial Services expenses as of March 31, 2011, employee severance benefits are included within selling, general and administrative expense while lease exit and other costs are included in other expense (income), net in the Consolidated Statements of Operations. The remaining liabilities for employee severance benefits and exited leases totaled $5.5 million and $37.9 million, respectively, at March 31, 2011 and $8.0 million and $41.7 million, respectively, at December 31, 2010. Substantially all of the employee severance benefits will be paid in 2011 while cash expenditures related to lease exit costs will be incurred over the remaining terms of the applicable leases, which generally extend several years. The restructuring costs relate to each of the Company’s reportable segments and were not material to any one segment.

 

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PULTEGROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

 

4. Inventory and land held for sale

Major components of the Company’s inventory were as follows ($000’s omitted):

 

     March 31,      December 31,  
     2011      2010  

Homes under construction

   $ 1,304,000       $ 1,331,618   

Land under development

     2,566,290         2,541,829   

Land held for future development

     896,926         908,366   
                 
   $ 4,767,216       $ 4,781,813   
                 

The Company capitalizes interest cost into inventory during the active development and construction of the Company’s communities. Each layer of capitalized interest is amortized over a period that approximates the average life of communities under development. Interest expense is allocated over the period based on the cyclical timing of unit settlements. Interest expensed to Homebuilding cost of revenues for the three months ended March 31, 2011 and 2010 included $0.1 million and $1.0 million, respectively, of capitalized interest related to land and community valuation adjustments. During the three months ended March 31, 2011 and 2010, the Company capitalized all of its Homebuilding interest costs into inventory because the level of the Company’s active inventory exceeded the Company’s debt levels.

Information related to interest capitalized into homebuilding inventory is as follows ($000’s omitted):

 

     Three Months Ended  
     March 31,  
     2011     2010  

Interest in inventory, beginning of period

   $ 323,379      $ 239,365   

Interest capitalized

     56,191        68,896   

Interest expensed

     (34,816     (27,000
                

Interest in inventory, end of period

   $ 344,754      $ 281,261   
                

Interest incurred*

   $ 56,191      $ 68,896   
                

 

* Homebuilding interest incurred includes interest on senior debt, short-term borrowings, and other financing arrangements and excludes interest incurred by the Financial Services segment and certain other interest costs.

Land Valuation Adjustments and Write-Offs

Land and community valuation adjustments

In accordance with ASC 360, “Property, Plant, and Equipment” (“ASC 360”), the Company records valuation adjustments on land inventory and related communities under development when events and circumstances indicate that they may be impaired and when the cash flows estimated to be generated by those assets are less than their carrying amounts. Such indicators include gross margin or sales paces significantly below expectations, construction costs or land development costs significantly in excess of budgeted amounts, significant delays or changes in the planned development for the community, and other known qualitative factors. For communities that are not yet active, a significant additional consideration includes an evaluation of the regulatory environment related to the probability, timing, and cost of obtaining necessary approvals from local municipalities and any potential concessions that may be necessary in order to obtain such approvals.

 

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PULTEGROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

 

 

4. Inventory and land held for sale (continued)

 

Land Valuation Adjustments and Write-Offs (continued)

Land and community valuation adjustments (continued)

 

The Company also considers potential changes to the product offerings in a community and any alternative strategies for the land, such as the sale of the land either in whole or in parcels. The weak market conditions throughout the homebuilding industry in recent years have resulted in lower than expected revenues and gross margins. As a result, a portion of the Company’s land inventory and communities under development demonstrated potential impairment indicators and were accordingly tested for impairment. As required by ASC 360, the Company compared the expected undiscounted cash flows for these communities to their carrying value. For those communities whose carrying values exceeded the expected undiscounted cash flows, the Company calculated the fair value of the community in accordance with ASC 360. Impairment charges are required to be recorded if the fair value of the community’s inventory is less than its carrying value.

The Company determines the fair value of a community’s inventory primarily using a combination of market comparable land transactions, where available, and discounted cash flow models. These estimated cash flows are significantly impacted by estimates related to expected average selling prices and sales incentives, expected sales paces and cancellation rates, expected land development and construction timelines, and anticipated land development, construction, and overhead costs. Such estimates must be made for each individual community and may vary significantly between communities. The assumptions used in the discounted cash flow models are specific to each community tested for impairment and typically do not assume improvements in market conditions 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. The Company’s determination of fair value also requires discounting the estimated cash flows at a rate commensurate with the inherent risks associated with each of the assets and related estimated cash flow streams. The discount rate used in determining each community’s fair value depends on the stage of development of the community and other specific factors that increase or decrease the inherent risks associated with the community’s cash flow streams. For example, communities that are entitled and near completion will generally require a lower discount rate than communities that are not entitled and consist of multiple phases spanning several years of development and construction activity.

The table below provides, as of the date indicated, the number of communities in which the Company recognized impairment charges, the fair value of those communities at such date (net of impairment charges), and the amount of impairment charges recognized ($ in millions):

 

     2011      2010  

Quarter Ended

   Number of
Communities
Impaired
     Fair Value of
Communities
Impaired, Net
of Impairment
Charges
     Impairment
Charges
     Number of
Communities
Impaired
     Fair Value of
Communities
Impaired, Net
of Impairment
Charges
     Impairment
Charges
 

March 31

     1       $ 0.5       $ 0.1         10       $ 7.2       $ 4.5   

 

 

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PULTEGROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

 

 

4. Inventory and land held for sale (continued)

 

Land Valuation Adjustments and Write-Offs (continued)

Land and community valuation adjustments (continued)

 

The Company recorded these valuation adjustments in its Consolidated Statements of Operations within Homebuilding home sale cost of revenues. During the three months ended March 31, 2011, the Company reviewed each of its land positions for potential impairment indicators and performed detailed impairment calculations for 11 communities. The discount rate used in the Company’s determination of fair value for the impaired community was 12%. During the three months ended March 31, 2011, the Company experienced relative stability in market conditions in accordance with its expectations, which resulted in total valuation adjustments significantly below those experienced in recent years. However, if conditions in the homebuilding industry or the Company’s local markets worsen in the future, the current difficult market conditions extend beyond the Company’s expectations, or the Company’s strategy related to certain communities changes, the Company may be required to evaluate its assets, including additional projects, for future impairments or write-downs, which could result in future charges that might be significant.

Net realizable value adjustments – land held for sale

The Company acquires land primarily for the construction of homes for sale to customers but periodically sells select parcels of land to third parties for commercial or other development. Additionally, the Company may determine that certain of its land assets no longer fit into its strategic operating plans. In such instances, the Company classifies the land asset as land held for sale, assuming the criteria in ASC 360 are met.

In accordance with ASC 360, the Company values land held for sale at the lower of carrying value or fair value less costs to sell. In determining the fair value of land held for sale, the Company considers recent legitimate offers received, prices for land in recent comparable sales transactions, and other factors. As a result of changing market conditions in the real estate industry, a portion of the Company’s land held for sale may be written down to net realizable value. There were no net realizable value adjustments during the three months ended March 31, 2011. During the three month period ended March 31, 2010, the Company recognized net realizable value adjustments of $0.6 million. The Company records these net realizable value adjustments in its Consolidated Statements of Operations within Homebuilding land sale cost of revenues.

The Company’s land held for sale was as follows ($000’s omitted):

 

     March 31,     December 31,  
     2011     2010  

Land held for sale, gross

   $ 146,241      $ 124,919   

Net realizable value reserves

     (49,551     (53,864
                

Land held for sale, net

   $ 96,690      $ 71,055   
                

Write-off of deposits and pre-acquisition costs

From time to time, the Company writes off certain deposits and pre-acquisition costs related to land option contracts the Company no longer plans to pursue. Such decisions take into consideration changes in national and local market conditions, the willingness of land sellers to modify terms of the related purchase agreement, the timing of required land takedowns, the availability and best use of necessary incremental capital, and other factors. The Company wrote off (net of recoveries) deposits and pre-acquisition costs in the amount of $0.6 million and $0.5 million during the three months ended March 31, 2011 and 2010, respectively. The Company records these write-offs of deposits and pre-acquisition costs in its Consolidated Statements of Operations within other expense (income), net.

 

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PULTEGROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

 

5. Segment information

The Company’s Homebuilding operating segments are engaged in the acquisition and development of land primarily for residential purposes within the continental United States and the construction of housing on such land targeted for first-time, first and second move-up, and active adult home buyers. The Company has determined that its Homebuilding operating segments are its Areas, each of which represents a reportable segment. In the fourth quarter of 2010, the Company realigned the organizational structure for certain of its Areas. The operating data by segment provided in this note have been reclassified to conform to the current presentation. Accordingly, the Company’s reportable Homebuilding segments are as follows:

 

East:   

Delaware, Georgia, Maryland, Massachusetts,

New Jersey, New York, North Carolina, Pennsylvania,

Rhode Island, South Carolina, Tennessee, Virginia

Gulf Coast:    Florida, Texas
Central:   

Arizona, Colorado, Illinois, Indiana, Missouri, Michigan,

Minnesota, New Mexico, Ohio

West:    California, Hawaii, Nevada, Oregon, Washington

The Company also has one reportable segment for its financial services operations, which consist principally of mortgage banking and title operations. The Company’s Financial Services segment operates generally in the same markets as the Company’s Homebuilding segments.

Evaluation of segment performance is based on operating earnings from continuing operations before provision for income taxes which, for the Homebuilding segments, is defined as home sale revenues and land sale revenues less home sale cost of revenues, land cost of revenues, and certain selling, general, and administrative and other expenses, plus equity income from unconsolidated entities, which are incurred by or allocated to the Homebuilding segments. Operating earnings for the Financial Services segment is defined as revenues less costs associated with the Company’s mortgage and title operations and certain selling, general, and administrative expenses incurred by or allocated to the Financial Services segment. Each reportable segment generally follows the same accounting policies described in Note 1 – “Summary of Significant Accounting Policies” to the consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010.

 

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PULTEGROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

 

 

5. Segment information (continued)

 

     Operating Data by Segment ($000’s omitted)  
     Three Months Ended
March 31,
 
     2011     2010  

Revenues:

    

East

   $ 268,866      $ 361,219   

Gulf Coast

     247,930        254,807   

Central

     146,581        187,251   

West

     120,390        186,515   
                
     783,767        989,792   

Financial Services

     21,435        30,566   
                

Consolidated revenues

   $ 805,202      $ 1,020,358   
                

Income (loss) before income taxes:

    

East

   $ 3,656      $ 14,589   

Gulf Coast

     3,977        (3,398

Central

     (12,315     (436

West

     2,092        10,548   

Other homebuilding (a)

     (38,204     (33,139
                
     (40,794     (11,836

Financial Services (b)

     973        5,472   

Other non-operating (c)

     (5,571     (8,144
                

Consolidated income (loss) before income taxes

   $ (45,392   $ (14,508
                

 

(a) Other homebuilding includes the amortization of intangible assets, goodwill impairment, and amortization of capitalized interest.
(b) Financial Services income before income taxes includes interest expense of $0.5 million for the three months ended March 31, 2010. There was no interest expense for the three months ended March 31, 2011. Financial Services income before income taxes includes interest income of $1.0 million and $1.4 million for the three months ended March 31, 2011 and 2010, respectively.
(c) Other non-operating includes the costs of certain shared services that benefit all operating segments, a portion of which are not allocated to the operating segments reported above.

 

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PULTEGROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

 

5. Segment information (continued)

 

     Valuation Adjustments  and
Write-Offs by Segment ($000’s omitted)
 
     Three Months Ended March 31,  
     2011      2010  

Land and community valuation adjustments:

     

East

   $ 41       $ —     

Gulf Coast

     —           2,751   

Central

     —           304   

West

     —           463   

Other homebuilding (a)

     62         1,019   
                 
   $ 103       $ 4,537   
                 

Net realizable value adjustments - land held for sale:

     

East

   $ —         $ —     

Gulf Coast

     —           505   

Central

     —           —     

West

     —           59   
                 
   $ —         $ 564   
                 

Write-off of deposits and pre-acquisition costs (b):

     

East

   $ 468       $ 37   

Gulf Coast

     13         474   

Central

     60         20   

West

     82         12   
                 
   $ 623       $ 543   
                 

Impairments of investments in unconsolidated joint ventures:

     

East

   $ —         $ —     

Gulf Coast

     —           —     

Central

     —           —     

West

     —           1,908   
                 
   $ —         $ 1,908   
                 

Total valuation adjustments and write-offs

   $ 726       $ 7,552   
                 

 

(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.

 

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PULTEGROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

 

 

5. Segment information (continued)

 

Total assets and inventory by reportable segment were as follows ($000’s omitted):

 

     March 31, 2011  
     Homes Under
Construction
     Land Under
Development
     Land Held
for Future
Development
     Total
Inventory
     Total
Assets
 

East

   $ 435,287       $ 820,243       $ 252,961       $ 1,508,491       $ 1,712,732   

Gulf Coast

     305,776         580,022         226,043         1,111,841         1,258,532   

Central

     291,475         584,501         118,202         994,178         1,054,808   

West

     224,586         361,810         219,625         806,021         912,850   

Other homebuilding (a)

     46,876         219,714         80,095         346,685         759,399   
                                            
     1,304,000         2,566,290         896,926         4,767,216         5,698,321   

Financial Services

     —           —           —           —           176,714   

Other non-operating (b)

     —           —           —           —           1,641,594   
                                            
   $ 1,304,000       $ 2,566,290       $ 896,926       $ 4,767,216       $ 7,516,629   
                                            
     December 31, 2010  
     Homes Under
Construction
     Land Under
Development
     Land Held
for Future
Development
     Total
Inventory
     Total
Assets
 

East

   $ 455,637       $ 792,586       $ 262,653       $ 1,510,876       $ 1,712,250   

Gulf Coast

     313,734         564,396         239,950         1,118,080         1,303,749   

Central

     302,456         592,049         120,566         1,015,071         1,067,917   

West

     215,971         387,661         208,542         812,174         915,519   

Other homebuilding (a)

     43,820         205,137         76,655         325,612         743,016   
                                            
     1,331,618         2,541,829         908,366         4,781,813         5,742,451   

Financial Services

     —           —           —           —           222,989   

Other non-operating (b)

     —           —           —           —           1,733,936   
                                            
   $ 1,331,618       $ 2,541,829       $ 908,366       $ 4,781,813       $ 7,699,376   
                                            

 

(a) Other homebuilding primarily includes operations in Puerto Rico, certain wind down operations, capitalized interest, goodwill, and intangibles.
(b) Other non-operating primarily includes cash and equivalents, income taxes receivable, and other corporate items that are not allocated to the operating segments.

 

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PULTEGROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

 

6. Investments in unconsolidated entities

The Company participates in a number of joint ventures with independent third parties. Many of these joint ventures purchase, develop, and/or sell land and homes in the United States and Puerto Rico. A summary of the Company’s joint ventures is presented below ($000’s omitted):

 

     March 31,
2011
     December 31,
2010
 

Investments in joint ventures with limited recourse guaranties

   $ 91       $ 122   

Investments in joint ventures with debt non-recourse to PulteGroup

     11,496         11,486   

Investments in other joint ventures

     33,883         34,705   
                 

Total investments in unconsolidated entities

   $ 45,470       $ 46,313   
                 

Total joint venture debt

   $ 14,285       $ 15,467   

PulteGroup’s proportionate share of joint venture debt:

     

Joint venture debt with limited recourse guaranties

   $ 1,448       $ 1,444   

Joint venture debt non-recourse to PulteGroup

     3,099         3,696   
                 

PulteGroup’s total proportionate share of joint venture debt

   $ 4,547       $ 5,140   
                 

The Company recognized income from its unconsolidated joint ventures of $1.1 million during the three months ended March 31, 2011. During the three months ended March 31, 2010, the Company recognized a loss of $0.1 million, which included impairments totaling $1.9 million. During the three months ended March 31, 2011 and 2010, the Company made capital contributions of $2.0 million and $1.2 million, respectively, to its joint ventures and received capital and earnings distributions of $1.4 million and $2.8 million, respectively, from its joint ventures.

The timing of cash obligations under the joint venture and related financing agreements varies by agreement and in certain instances is contingent upon the joint venture’s sale of its land holdings. If additional capital infusions are required and approved, the Company would need to contribute its pro rata portion of those capital needs in order not to dilute its ownership in the joint ventures. While future capital contributions may be required, the Company believes the total amount of such contributions will be limited. The Company’s maximum financial loss exposure related to joint ventures is unlikely to exceed the combined investment and limited recourse guaranty totals.

A terminated joint venture financing agreement required the Company and other members of one joint venture to guaranty for the benefit of the lender the completion of the project if the joint venture did not perform the required development and an increment of interest in certain circumstances. This joint venture defaulted under its debt agreement, and the lender foreclosed on the joint venture’s property that served as collateral. During 2008, the lender also filed suit against the majority of the members of the joint venture, including the Company, in an effort to enforce the completion guaranty. In March 2011, the parties to this litigation executed a settlement agreement, and the Company paid its proportionate share of such settlement, which did not have a material impact on the Company’s financial position, results of operations, or cash flows.

Additionally, the Company has agreed to indemnify the lenders for a joint venture with limited recourse guaranties for certain environmental contingencies, and the guaranty arrangements provide that the Company is responsible for its proportionate share of the outstanding debt if the joint venture voluntarily files for bankruptcy. The Company would not be responsible under these guaranties unless the joint venture was unable to meet its contractual borrowing obligations or in instances of fraud, misrepresentation, or other bad faith actions by the Company. To date, the Company has not been requested to perform under the bankruptcy or environmental guaranties described above.

In addition to the joint ventures with limited recourse guaranties, the Company has investments in other unconsolidated entities, some of which have debt. These investments include the Company’s joint ventures in Puerto Rico, which are in the final stages of liquidation. The Company does not have any significant financing exposures related to these entities.

 

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PULTEGROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

 

7. Shareholders’ equity

Pursuant to the two $100 million stock repurchase programs authorized by the Board of Directors in October 2002 and 2005, and the $200 million stock repurchase program authorized in February 2006 (for a total stock repurchase authorization of $400 million), the Company has repurchased a total of 9,688,900 shares for a total of $297.7 million, though there have been no repurchases under these programs since 2006. The Company had remaining authorization to purchase $102.3 million of common stock at March 31, 2011.

Under its stock-based compensation plans, the Company accepts shares as payment under certain conditions related to stock option exercises and vesting of restricted stock, generally related to the payment of minimum tax obligations. During the three months ended March 31, 2011 and 2010, the Company repurchased $1.0 million and $1.7 million, respectively, of shares from employees under these plans. Such repurchases are excluded from the $400 million stock repurchase authorization.

Accumulated other comprehensive income (loss)

The accumulated balances related to each component of other comprehensive income (loss) are as follows ($000’s omitted):

 

     March 31,
2011
    December 31,
2010
 

Foreign currency translation adjustments:

    

Mexico

   $ —        $ 51   

Fair value of derivatives, net of income taxes of $2,086 in 2011 and 2010

     (1,561     (1,570
                
   $ (1,561   $ (1,519
                

 

8. Income taxes

The Company’s income tax benefit for the three months ended March 31, 2011 and 2010 was $5.9 million and $2.0 million, respectively. Due to the effects of the deferred tax valuation allowance and changes in unrecognized tax benefits, the Company’s effective tax rates in 2011 and 2010 are not meaningful as the income tax benefit is not directly correlated to the amount of pretax loss. The income tax benefits for the three months ended March 31, 2011 and 2010 resulted primarily from the favorable resolution of certain income tax matters.

The Company had income taxes receivable of $79.4 million and $81.3 million at March 31, 2011 and December 31, 2010, respectively. Income taxes receivable at March 31, 2011 and December 31, 2010 generally relate to outstanding federal and state tax refunds from amended returns and net operating loss carrybacks.

In accordance with ASC 740, “Income Taxes,” the Company evaluates its deferred tax assets to determine if a valuation allowance is required. At March 31, 2011 and December 31, 2010, the Company had net deferred tax assets of $2.6 billion, which were offset entirely by valuation allowances due to the uncertainty of realizing such deferred tax assets. The ultimate realization of these deferred tax assets is dependent upon the generation of taxable income during future periods. Changes in existing tax laws could also affect actual tax results and the valuation of deferred tax assets over time. The accounting for deferred taxes is based upon an estimate of future results. Differences between the estimated and actual results could have a material impact on the Company’s consolidated results of operations or financial position. To the extent that the Company’s results of operations improve, the deferred tax asset valuation allowance may be reduced, which would result in a non-cash tax benefit.

As a result of the Company’s merger with Centex, the Company’s ability to use certain of Centex’s pre-ownership net operating losses and built-in losses or deductions will be limited under Section 382 of the Internal Revenue Code. The Company’s Section 382 limitation is approximately $67.4 million per year for net operating losses, 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 net operating loss carryforwards, built-in losses, and certain deductions not being available for use by the Company.

 

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PULTEGROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

 

 

8. Income taxes (continued)

 

At March 31, 2011, the Company had $248.6 million of gross unrecognized tax benefits and $47.9 million of accrued penalties and interest. The Company is currently under examination by the IRS and various state taxing jurisdictions and anticipates finalizing certain of the examinations within the next twelve months. The final outcome of those examinations is not yet determinable. It is reasonably possible, within the next twelve months, that the Company’s unrecognized tax benefits may decrease by $104.7 million, excluding interest and penalties, primarily due to expirations of certain statutes of limitations and potential settlements. The statutes of limitations for the Company’s major tax jurisdictions remain open for examination for tax years 1998-2011.

 

9. 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.

The Company’s financial instruments measured at fair value on a recurring basis are summarized below ($000’s omitted):

 

            Fair Value  

Financial Instrument

   Fair Value
Hierarchy
     March 31,
2011
    December 31,
2010
 

Residential mortgage loans available-for-sale

     Level 2       $ 143,846      $ 176,164   

Whole loan commitments

     Level 2         881        2,319   

Interest rate lock commitments

     Level 2         4,000        2,692   

Forward contracts

     Level 2         (682     3,544   

See Note 1 of these Consolidated Financial Statements regarding the fair value of mortgage loans available-for-sale and derivative instruments and hedging activities.

In addition, certain of the Company’s assets are required to be recorded at fair value on a non-recurring basis when events and circumstances indicate that the carrying value may not be recoverable. The Company’s assets measured at fair value on a non-recurring basis are summarized below ($000’s omitted):

 

            Fair Value  
      Fair Value
Hierarchy
     March 31,
2011
     December 31,
2010
 

Loans held for investment

     Level 2       $ 2,170       $ 3,002   

House and land inventory

     Level 3         483         70,862   

The fair values included in the table above represent only those assets whose carrying values were adjusted to fair value in the current quarter. The Company measured certain of its loans held for investment at fair value because the cost of the loans exceeded their fair value. Fair value of the loans was determined based on the fair value of the underlying collateral. For house and land inventory, see Note 4 of these Consolidated Financial Statements for a more detailed discussion of the valuation method used.

 

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PULTEGROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

 

 

9. Fair value disclosures (continued)

 

The carrying amounts of cash and equivalents approximate their fair values due to their short-term nature. The fair values of senior notes are based on quoted market prices, when available. If quoted market prices are not available, fair values are based on quoted market prices of similar issues. At March 31, 2011, the fair value of the senior notes outstanding approximated $3.3 billion. The carrying values of the senior notes are presented in Note 10. The carrying value of collateralized short-term debt approximates fair value.

 

10. Debt and other financing arrangements

The Company’s senior notes are summarized as follows:

 

     March 31,
2011
     December 31,
2010
 

8.125% unsecured senior notes due February 2011 (a)

   $ —         $ 13,900   

5.45% unsecured senior notes due August 2012 (b)

     104,650         104,823   

6.25% unsecured senior notes due February 2013 (b)

     62,632         62,617   

5.125% unsecured senior notes due October 2013 (b)

     160,663         160,212   

5.25% unsecured senior notes due January 2014 (b)

     335,854         335,848   

5.70% unsecured senior notes due May 2014 (b)

     309,761         309,048   

5.20% unsecured senior notes due January 2015 (b)

     244,850         244,839   

5.25% unsecured senior notes due June 2015 (b)

     399,201         397,700   

6.50% unsecured senior notes due May 2016 (b)

     467,268         466,644   

7.625% unsecured senior notes due September 2017 (a)

     149,292         149,265   

7.875% unsecured senior notes due May 2032 (b)

     299,076         299,065   

6.375% unsecured senior notes due May 2033 (b)

     398,363         398,344   

6.00% unsecured senior notes due January 2035 (b)

     299,370         299,363   

7.375% unsecured senior notes due June 2046 (c)

     150,000         150,000   
                 

Total senior notes - carrying value (d)

   $ 3,380,980       $ 3,391,668   
                 

Estimated fair value

   $ 3,279,168       $ 3,227,404   
                 

 

(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) Callable at par on or after June 1, 2011, guaranteed on a senior basis by certain wholly-owned subsidiaries
(d) 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

Letter of credit facilities

As a cost-saving measure and to provide increased operational flexibility, the Company voluntarily terminated its $250.0 million unsecured revolving credit facility effective March 30, 2011. The credit facility was scheduled to expire in June 2012, had no borrowings outstanding, and was being used solely to issue letters of credit ($221.6 million outstanding at December 31, 2010). The Company did not pay any penalties as a result of the termination. The termination of the facility also:

 

   

released the $250.0 million of cash required by the credit facility to be maintained in liquidity reserve accounts;

 

   

released the Company from the credit facility’s covenant requirements, which included, among other things, a maximum debt to tangible capital ratio and a tangible net worth minimum; and

 

   

resulted in expense of $1.3 million related to the write-off of unamortized issuance costs, which is included in the Consolidated Statements of Operations within selling, general and administrative expenses.

In connection with the termination of the credit facility, the Company entered into separate cash-collateralized letter of credit agreements with a number of different financial institutions. These agreements provide capacity to issue letters of credit totaling up to $192.0 million, of which $109.7 million was outstanding at March 31, 2011. Under these agreements, the Company is required to maintain deposits with these financial institutions in amounts approximating the letters of credit outstanding. Such deposits are included in restricted cash on the Consolidated Balance Sheet.

 

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PULTEGROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

 

 

10. Debt and other financing arrangements (continued)

 

The Company also maintains an unsecured letter of credit facility with Deutsche Bank AG, New York Branch that expires in June 2014 and permits the issuance of up to $200.0 million of letters of credit by the Company. At March 31, 2011 and December 31, 2010, $153.0 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 the Company’s home sales utilizing its own funds and borrowings made available pursuant to certain repurchase agreements. 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 the Company’s strong 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.

 

11. Commitments and contingencies

Loan origination liabilities

The Company’s mortgage operations have established liabilities for anticipated losses associated with mortgage loans originated and sold to investors that may result from 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. If determined to be at fault, the Company either repurchases the loans from the investors or reimburses the investors’ losses. The Company establishes liabilities for such anticipated losses based upon, among other things, the level of current and estimated probable future repurchase demands made by investors, the ability of the Company to cure the defects identified in the repurchase demands, and the severity of the loss upon repurchase. Beginning in 2009, the Company experienced a significant increase in anticipated losses as a result of the high level of loan defaults and related losses in the mortgage industry and increasing aggressiveness by investors in presenting such claims to the Company. The vast majority of these losses relate to loans originated in 2006 and 2007 when industry lending standards were less stringent and borrower fraud is believed to have peaked. Given the volatility in the mortgage industry and the uncertainty regarding the ultimate resolution of these claims, it is reasonably possible that future losses may exceed the Company’s current estimates. Changes in these liabilities are as follows ($000’s omitted):

 

     Three Months Ended
March 31,
 
     2011     2010  

Liabilities, beginning of period

   $ 93,057      $ 105,914   

Provision for losses

     —          (354

Settlements

     (10,597     (11,472
                

Liabilities, end of period

   $ 82,460      $ 94,088   
                

 

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Table of Contents

PULTEGROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

 

 

11. Commitments and contingencies (continued)

 

Community development and other special district obligations

A community development district or similar development authority (“CDD”) is a unit of local government created under various state statutes that utilizes the proceeds from the sale of bonds to finance the construction or acquisition of infrastructure assets of a development. A portion of the liability associated with the bonds, including principal and interest, is assigned to each parcel of land within the development. This debt is typically paid by subsequent special assessments levied by the CDD on the landowners. Generally, the Company is only responsible for paying the special assessments for the period in which it is the landowner of the applicable parcels. However, in certain limited instances the Company records a liability for future assessments that are fixed or determinable for a fixed or determinable period in accordance with ASC 970-470, “Real Estate Debt”. At March 31, 2011 and December 31, 2010, the Company had recorded $43.6 million and $73.3 million, respectively, in accrued liabilities for outstanding CDD obligations. During 2011, the Company voluntarily repurchased at a discount prior to their maturity CDD obligations with an aggregate principal balance of $27.5 million in order to improve the future financial performance of the related communities. The discount of $5.3 million will be 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, the Company posts letters of credit and surety bonds pursuant to certain performance related obligations, as security for certain land option agreements, and under various insurance programs. At March 31, 2011 and December 31, 2010 the Company had outstanding letters of credit and surety bonds totaling $1.6 billion and $1.7 billion, respectively.

In addition, the Company was previously subject to $817.4 million of surety bonds related to certain construction obligations of Centex’s previous commercial construction business, which was sold by Centex on March 30, 2007. The Company estimated that less than $85.0 million of work remained to be performed on these commercial construction projects as of December 31, 2010. The purchaser of the Centex commercial construction business had previously indemnified the Company against potential losses relating to such surety bond obligations, and the Company had purchased for its benefit a back-up indemnity provided by a financial institution as additional security. During 2011, the Company restructured this arrangement such that the Company is no longer directly subject to the surety bonds and is only contingently liable in the event of non-performance by the purchaser of the Centex commercial construction business and its parent company as well as exhaustion of a letter of credit in excess of the estimated amount of work remaining posted by the purchaser with the surety. Accordingly, the Company terminated the back-up indemnity as it believes the risk of this exposure becoming a cash obligation to the Company is not significant.

Litigation

The Company is involved in various litigation and legal claims in the normal course of its business operations, including actions brought on behalf of various classes of claimants. The Company is 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 administering governmental agencies.

The Company establishes a liability for potential legal claims and regulatory matters when such matters are both probable of occurring and any potential loss is reasonably estimable. The Company accrues for such matters based on the facts and circumstances specific to each matter and revises 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, the Company 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, management does not believe that the resolution of such matters will have a material adverse impact on the results of operations, financial position, or cash flows of the Company. 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.

 

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Table of Contents

PULTEGROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

 

 

11. Commitments and contingencies (continued)

 

Self-insured risks

The Company maintains, and requires the majority of its subcontractors to maintain, general liability insurance coverage, including coverage for certain construction defects. The Company also maintains property, errors and omissions, workers compensation, and other business insurance coverage. These insurance policies protect the Company against a portion of the risk of loss from claims. However, the Company retains a significant portion of the overall risk for such claims either through policies issued by the Company’s captive insurance subsidiaries or through its own self-insured per occurrence and aggregate retentions, deductibles, and available policy limits. The availability of general liability insurance for the homebuilding industry and its subcontractors has become increasingly limited and more expensive in recent years. In certain instances, the Company may offer its subcontractors the opportunity to purchase insurance through one of the Company’s captive insurance subsidiaries or to participate in a project specific insurance program provided by the Company. Any policy issued by the captive insurance subsidiaries represents self-insurance of these risks by the Company. While general liability coverage for the homebuilding industry is complex and the Company’s coverage varies significantly based on the policy year, in recent years the Company is generally self-insured for $5.0 million to $7.5 million on a per occurrence basis and up to $60.0 million on an annual aggregate basis, at which point our excess or reinsurance coverage begins. The Company’s insurance policies are maintained with highly-rated underwriters for whom the Company believes counterparty default risk is not significant.

The Company generally reserves for costs associated with insurance claims and their related lawsuits (including expected legal fees) based on an actuarial analysis of the Company’s historical claims. The actuarial analysis includes an estimate of claims incurred but not reported. These estimates make up a significant portion of the Company’s estimates and are subject to a high degree of uncertainty due to a variety of factors, including changes in claims reporting and resolution patterns, third party recoveries, insurance industry practices, the regulatory environment, and legal precedent. State regulations vary, but construction defect claims are reported and resolved over an extended period often exceeding ten years. In certain instances, the Company has the ability to recover a portion of its costs under various insurance policies or from its subcontractors or other third parties. Estimates of such amounts are recorded when recovery is considered probable. The actuarial analyses of the reserves also consider historical third party recovery rates. As a result of the inherent uncertainty related to each of these factors, actual costs could differ significantly from estimated costs.

Adjustments to estimated reserves are recorded in the period in which the change in estimate occurs. The recorded reserves include an actuarial assessment of incurred but not reported claims, which represent the majority of the total reserves. Changes in the number and timing of reported claims and the estimates of specific claim values will significantly impact estimates of future reserves, which are reflected by the incurred but not reported reserve. Changes in these liabilities are as follows ($000’s omitted):

 

     Three Months Ended
March 31,
 
     2011     2010  

Balance, beginning of period

   $ 813,841      $ 566,693   

Reserves provided

     14,924        16,313   

Payments

     (24,699     (13,340
                

Balance, end of period

   $ 804,066      $ 569,666   
                

The Company’s insurance-related expenses as reflected in the above table are reflected in the Consolidated Statements of Operations within selling, general, and administrative expenses. The Company has experienced a high level of insurance-related expenses in recent years, primarily due to the adverse development of construction defect claims, the frequency and severity of which have increased significantly over historical levels. The higher reserve balance at March 31, 2011 compared with March 31, 2010 resulted from recording additional expense to insurance reserves in the third quarter of 2010 when the Company experienced a greater than anticipated frequency of newly reported claims and an increase in specific case reserves related to known claims for homes closed in prior periods, including several large claims.

 

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Table of Contents

PULTEGROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

 

12. Supplemental Guarantor information

All of the Company’s senior notes are guaranteed jointly and severally on a senior basis by each of the Company’s wholly-owned Homebuilding subsidiaries and certain other wholly-owned subsidiaries (collectively, the “Guarantors”). Such guaranties are full and unconditional. Supplemental consolidating financial information of the Company, including such information for the Guarantors, is presented below. Investments in subsidiaries are presented using the equity method of accounting. Separate financial statements of the Guarantors are not provided as the consolidating financial information contained herein provides a more meaningful disclosure to allow investors to determine the nature of the assets held by, and the operations of, the combined groups.

 

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Table of Contents

PULTEGROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

 

 

12. Supplemental Guarantor information (continued)

 

CONDENSED CONSOLIDATING BALANCE SHEET

March 31, 2011

($000’s omitted)

 

     Unconsolidated              
     PulteGroup,
Inc.
    Guarantor
Subsidiaries
     Non-Guarantor
Subsidiaries
    Eliminating
Entries
    Consolidated
PulteGroup,
Inc.
 

ASSETS

           

Cash and equivalents

   $ 92,582      $ 858,726       $ 341,641      $ —        $ 1,292,949   

Restricted cash

     109,667        4,595         19,142        —          133,404   

Unfunded settlements

     —          17,275         (4,802     —          12,473   

House and land inventory

     —          4,763,084         4,132        —          4,767,216   

Land held for sale

     —          96,690         —          —          96,690   

Land, not owned, under option agreements

     —          43,271         —          —          43,271   

Residential mortgage loans available-for-sale

     —          —           143,846        —          143,846   

Securities purchased under agreements to resell

     35,501        —           (35,501       —     

Investments in unconsolidated entities

     1,523        41,357         2,590        —          45,470   

Goodwill

     —          240,541         —          —          240,541   

Intangible assets, net

     —          172,173         —          —          172,173   

Other assets

     22,059        432,104         34,984        —          489,147   

Income taxes receivable

     79,449        —           —          —          79,449   

Deferred income tax assets

     (34,620     27         34,593        —          —     

Investments in subsidiaries and intercompany accounts, net

     5,562,123        6,047,433         6,218,542        (17,828,098     —     
                                         
   $ 5,868,284      $ 12,717,276       $ 6,759,167      $ (17,828,098   $ 7,516,629   
                                         

LIABILITIES AND SHAREHOLDERS’ EQUITY

           

Liabilities:

           

Accounts payable, customer deposits, accrued and other liabilities

   $ 97,559      $ 1,049,090       $ 599,255      $ —        $ 1,745,904   

Income tax liabilities

     289,605        —           —          —          289,605   

Senior notes

     3,380,980        —           —          —          3,380,980   
                                         

Total liabilities

     3,768,144        1,049,090         599,255        —          5,416,489   

Total shareholders’ equity

     2,100,140        11,668,186         6,159,912        (17,828,098     2,100,140   
                                         
   $ 5,868,284      $ 12,717,276       $ 6,759,167      $ (17,828,098   $ 7,516,629   
                                         

 

28


Table of Contents

PULTEGROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

 

 

12. Supplemental Guarantor information (continued)

 

CONDENSED CONSOLIDATING BALANCE SHEET

December 31, 2010

($000’s omitted)

 

     Unconsolidated              
     PulteGroup,
Inc.
    Guarantor
Subsidiaries
     Non-Guarantor
Subsidiaries
    Eliminating
Entries
    Consolidated
PulteGroup,
Inc.
 

ASSETS

           

Cash and equivalents

   $ 10,000      $ 1,089,439       $ 371,186      $ —        $ 1,470,625   

Restricted cash

     —          3,927         20,674        —          24,601   

Unfunded settlements

     —          17,184         (4,419     —          12,765   

House and land inventory

     —          4,777,681         4,132        —          4,781,813   

Land held for sale

     —          71,055         —          —          71,055   

Land, not owned, under option agreements

     —          50,781         —          —          50,781   

Residential mortgage loans available-for-sale

     —          —           176,164        —          176,164   

Securities purchased under agreements to resell

     74,500        —           (74,500    

Investments in unconsolidated entities

     1,523        42,261         2,529        —          46,313   

Goodwill

     —          240,541         —          —          240,541   

Intangible assets, net

     —          175,448         —          —          175,448   

Other assets

     24,476        499,075         44,412        —          567,963   

Income taxes receivable

     81,307        —           —          —          81,307   

Deferred income tax assets

     (34,192     27         34,165        —          —     

Investments in subsidiaries and intercompany accounts, net

     5,749,695        5,783,384         6,265,591        (17,798,670     —     
                                         
   $ 5,907,309      $ 12,750,803       $ 6,839,934      $ (17,798,670   $ 7,699,376   
           

LIABILITIES AND SHAREHOLDERS’ EQUITY

           

Liabilities:

           

Accounts payable, customer deposits, accrued and other liabilities

   $ 86,066      $ 1,166,805       $ 625,262      $ —        $ 1,878,133   

Income tax liabilities

     294,408        —           —          —          294,408   

Senior notes

     3,391,668        —           —          —          3,391,668   
                                         

Total liabilities

     3,772,142        1,166,805         625,262        —          5,564,209   

Total shareholders’ equity

     2,135,167        11,583,998         6,214,672        (17,798,670     2,135,167   
                                         
   $ 5,907,309      $ 12,750,803       $ 6,839,934      $ (17,798,670   $ 7,699,376   
                                         

 

29


Table of Contents

PULTEGROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

 

 

12. Supplemental Guarantor information (continued)

 

CONSOLIDATING STATEMENT OF OPERATIONS

For the three months ended March 31, 2011

($000’s omitted)

 

     Unconsolidated               
     PulteGroup,
Inc.
    Guarantor
Subsidiaries
    Non-
Guarantor
Subsidiaries
    Eliminating
Entries
     Consolidated
PulteGroup,
Inc.
 

Revenues

           

Homebuilding

           

Home sale revenues

   $ —        $ 782,471      $ —        $ —         $ 782,471   

Land sale revenues

     —          1,296        —          —           1,296   
                                         
     —          783,767        —          —           783,767   

Financial Services

     —          283        21,152        —           21,435   
                                         
     —          784,050        21,152        —           805,202   
                                         

Homebuilding Cost of Revenues

           

Home sale cost of revenues

     —          685,030        —          —           685,030   

Land sale cost of revenues

     —          930        —          —           930   
                                         
     —          685,960        —          —           685,960   

Financial Services expenses

     145        146        20,182        —           20,473   

Selling, general, and administrative expenses

     10,993        129,293        2,160        —           142,446   

Other expense (income), net

     41        4,743        (874     —           3,910   

Interest income

     —          (1,327     (110     —           (1,437

Interest expense

     351        —          —          —           351   

Intercompany interest

     10,712        (8,644     (2,068     —           —     

Equity in (earnings) loss of unconsolidated entities

     —          (1,049     (60     —           (1,109
                                         

Income (loss) before income taxes and equity in income (loss) of subsidiaries

     (22,242     (25,072     1,922        —           (45,392

Income tax expense (benefit)

     (707     (5,801     642        —           (5,866
                                         

Income (loss) before equity in income (loss) of subsidiaries

     (21,535     (19,271     1,280        —           (39,526

Equity in income (loss) of subsidiaries

     (17,991     1,560        (67,311     83,742         —     
                                         

Net income (loss)

   $ (39,526   $ (17,711   $ (66,031   $ 83,742       $ (39,526
                                         

 

30


Table of Contents

PULTEGROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

 

 

12. Supplemental Guarantor information (continued)

 

CONSOLIDATING STATEMENT OF OPERATIONS

For the three months ended March 31, 2010

($000’s omitted)

 

     Unconsolidated              
     PulteGroup,
Inc.
    Guarantor
Subsidiaries
    Non-
Guarantor
Subsidiaries
    Eliminating
Entries
    Consolidated
PulteGroup,
Inc.
 

Revenues

          

Homebuilding

          

Home sale revenues

   $ —        $ 976,806      $ —        $ —        $ 976,806   

Land sale revenues

     —          12,986        —          —          12,986   
                                        
     —          989,792        —          —          989,792   

Financial Services

     —          922        29,644        —          30,566   
                                        
     —          990,714        29,644        —          1,020,358   
                                        

Homebuilding Cost of Revenues

          

Home sale cost of revenues

     —          850,095        —          —          850,095   

Land sale cost of revenues

     —          8,998        —          —          8,998   
                                        
     —          859,093        —          —          859,093   

Financial Services expenses

     183        753        24,175        —          25,111   

Selling, general, and administrative expenses

     17,981        132,289        11,036        —          161,306   

Other expense (income), net

     (9     (6,111     (2,321     —          (8,441

Interest income

     —          (936     (1,843     —          (2,779

Interest expense

     482        —          —          —          482   

Intercompany interest

     41,040        (41,040     —          —          —     

Equity in (earnings) loss of unconsolidated entities

     (6     366        (266     —          94   
                                        

Income (loss) before income taxes and equity in income (loss) of subsidiaries

     (59,671     46,300        (1,137     —          (14,508

Income tax expense (benefit)

     (10,139     9,071        (952     —          (2,020
                                        

Income (loss) before equity in income (loss) of subsidiaries

     (49,532     37,229        (185     —          (12,488

Equity in income (loss) of subsidiaries

     37,044        6,948        36,615        (80,607     —     
                                        

Net income (loss)

   $ (12,488   $ 44,177      $ 36,430      $ (80,607   $ (12,488
                                        

 

31


Table of Contents

PULTEGROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

 

 

12. Supplemental Guarantor information (continued)

 

CONSOLIDATING STATEMENT OF CASH FLOWS

For the three months ended March 31, 2011

($000’s omitted)

 

     Unconsolidated               
     PulteGroup,
Inc.
    Guarantor
Subsidiaries
    Non-Guarantor
Subsidiaries
    Eliminating
Entries
     Consolidated
PulteGroup,
Inc.
 

Net cash provided by (used in) operating activities

   $ (105,125   $ (73,478   $ 19,587      $ —         $ (159,016
                                         

Cash flows from investing activities:

           

Distributions from unconsolidated entities

     —          1,021        —          —           1,021   

Investments in unconsolidated entities

     —          (1,968     —          —           (1,968

Net change in loans held for investment

     —          —          255        —           255   

Proceeds from the sale of fixed assets

     —          2,441        —          —           2,441   

Capital expenditures

     —          (5,097     (1,031     —           (6,128
                                         

Net cash provided by (used in) investing activities

     —          (3,603     (776     —           (4,379
                                         

Cash flows from financing activities:

           

Repayments of other borrowings

     (13,902     590        —          —           (13,312

Intercompany activities, net

     202,578        (154,222     (48,356     —           —     

Stock repurchases

     (969     —          —          —           (969
                                         

Net cash provided by (used in) financing activities

     187,707        (153,632     (48,356     —           (14,281
                                         

Net increase (decrease) in cash and equivalents

     82,582        (230,713     (29,545     —           (177,676

Cash and equivalents at beginning of period

     10,000        1,089,439        371,186        —           1,470,625   
                                         

Cash and equivalents at end of period

   $ 92,582      $ 858,726      $ 341,641      $ —         $ 1,292,949   
                                         

 

32


Table of Contents

PULTEGROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

 

 

12. Supplemental Guarantor information (continued)

 

CONSOLIDATING STATEMENT OF CASH FLOWS

For the three months ended March 31, 2010

($000’s omitted)

 

     Unconsolidated               
     PulteGroup,
Inc.
    Guarantor
Subsidiaries
    Non-Guarantor
Subsidiaries
    Eliminating
Entries
     Consolidated
PulteGroup,
Inc.
 

Net cash provided by (used in) operating activities

   $ 737,184      $ (45,562   $ (14,055   $ —         $ 677,567   
                                         

Cash flows from investing activities:

           

Distributions from unconsolidated entities

     —          2,842        —          —           2,842   

Investments in unconsolidated entities

     —          (1,217     —          —           (1,217

Net change in loans held for investment

     —          —          563        —           563   

Proceeds from the sale of fixed assets

     —          476        —          —           476   

Capital expenditures

     —          (2,787     (538     —           (3,325
                                         

Net cash provided by (used in) investing activities

     —          (686     25        —           (661
                                         

Cash flows from financing activities:

           

Net repayments under Financial Services credit arrangements

     —          —          40,250        —           40,250   

Repayment of other borrowings

     —          (130     —          —           (130

Intercompany activities, net

     (743,576     757,678        (14,102     —           —     

Issuance of common stock

     8,089        —          —          —           8,089   

Stock repurchases

     (1,697     —          —          —           (1,697
                                         

Net cash provided by (used in) financing activities

     (737,184     757,548        26,148        —           46,512   
                                         

Net increase (decrease) in cash and equivalents

     —          711,300        12,118        —           723,418   

Cash and equivalents at beginning of period

     —          1,501,684        356,550        —           1,858,234   
                                         

Cash and equivalents at end of period

   $ —        $ 2,212,984      $ 368,668      $ —         $ 2,581,652   
                                         

 

33


Table of Contents
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

Since early 2006, the U.S. housing market has been unfavorably impacted by a lack of consumer confidence, large supplies of housing inventories, and related pricing pressures, among other factors. When combined with the significant foreclosure activity, more challenging appraisal environment, higher than normal unemployment levels, and uncertainty in the U.S. economy in recent periods, these conditions have contributed to weakened demand for new homes, slower sales, higher cancellation rates, and increased price discounts and sales incentives to attract homebuyers. As a result, we have experienced a net loss in each quarter since the fourth quarter of 2006. Such losses resulted from a combination of reduced operational profitability and significant asset impairments.

The U.S. housing market and broader economy remain in a period of uncertainty. While we are beginning to see signs of stabilization in certain of our local markets, homebuilding industry volumes remain at near historically low levels. We are encouraged by our net new order levels for the first quarter of 2011, which exceeded our expectations. The more stable environment in the homebuilding industry in recent months resulted in a significant reduction in the level of land-related charges recorded during the first quarter of 2011 compared with recent periods. We also believe that our strategic merger with Centex (completed in August 2009) positions us well for an eventual recovery in the homebuilding industry. However, significant short-term uncertainty remains such that we are not anticipating a broad recovery in homebuilding during 2011. Factors that may further worsen market conditions or delay a recovery in the homebuilding industry include:

 

   

High levels of unemployment, which are generally not expected to recede to historical levels during 2011, and associated low levels of consumer confidence;

 

   

Continued high levels of foreclosure activity;

 

   

Potentially higher mortgage interest rates, which might result from a variety of macroeconomic factors, as the historically low rates prevailing in recent periods are not believed to be sustainable for the long-term;

 

   

Increased costs and standards related to FHA loans, which continue to be a significant source of customer financing;

 

   

The overall impact of the federal government’s intervention in the U.S. economy; and

 

   

Potential impacts of reforms to the overall U.S. financial services and mortgage industries that may have an adverse impact on the ability of our customers to finance their home purchases or on our access to the capital markets, including the Dodd-Frank Wall Street Reform and Consumer Protection Act enacted into law on July 21, 2010, potential reform of the mortgage interest deduction and the potential re-privatization of the government-sponsored enterprises commonly known as Fannie Mae and Freddie Mac.

We believe that improved employment levels and consumer confidence are necessary to unleash the pent-up demand that 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 select land positions where it makes strategic and economic sense to do so, our preferred profile for such investments generally consists of developed lots, frequently under rolling lot option contracts, that are cash flow positive early in the project cycle and accretive to earnings. We also continue to evaluate each existing land parcel to determine whether the strategy and economics support holding the parcel or disposing of it. We have closely evaluated and made significant reductions in employee headcount and overhead expenses since the beginning of the industry downturn. Due to the persistence of these difficult market conditions, improving the efficiency of our overhead costs will continue to be a significant area of focus. 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.

While signs of improvement for the overall U.S. economy, employment, and consumer confidence provide reasons for some level of optimism, our outlook is tempered for 2011 as the timing of a sustainable recovery in the homebuilding industry remains uncertain. In the long-term, we continue to believe that builders with strong land positions, broad geographic and product diversity, and access to lower-cost capital will benefit as market conditions recover. In the short-term, conditions will remain challenging, and certain of our local markets may continue to experience volatility. We believe that improved gross margins combined with higher volumes and greater overhead leverage should lead to profitability in the second half of 2011. However, given the continued weakness in new home sales, 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, or if our strategy related to certain communities changes, we may be required to evaluate our assets, including additional projects, for further impairments or write-downs, which could result in future charges that might be significant.

 

34


Table of Contents

Overview (continued)

 

The following is a summary of our operating results by line of business for the three months ended March 31, 2011 and 2010 ($000’s omitted, except per share data):

 

     Three Months Ended
March 31,
 
     2011     2010  

Income (loss) before income taxes:

    

Homebuilding

   $ (40,794   $ (11,836

Financial Services

     973        5,472   

Other non-operating

     (5,571     (8,144
                

Income (loss) before income taxes

     (45,392     (14,508

Income tax expense (benefit)

     (5,866     (2,020
                

Net income (loss)

   $ (39,526   $ (12,488
                

Per share data - assuming dilution:

    

Net income (loss)

   $ (0.10   $ (0.03
                

The following is a comparison of our loss before income taxes for 2011 and 2010:

 

   

Homebuilding continued to experience declining revenues and challenged gross margins. The revenue decline for 2011 is due in part to the impact of a federal homebuyer tax credit that existed during 2010 as well as a lower active community count in 2011. The lower volume was partially offset by lower selling, general and administrative expenses.

 

   

Financial Services remained profitable, though at a decreased level compared with 2010 due to lower loan origination volumes resulting from the lower Homebuilding volumes.

 

   

Our Other non-operating loss improved compared with the prior year period primarily due to reduced compensation costs partially offset by lower interest income.

 

35


Table of Contents

Homebuilding Operations – Summary

The following table presents a summary of pre-tax loss and unit information for our Homebuilding operations for the three months ended March 31, 2011 and 2010 ($000’s omitted):

 

     Three Months Ended
March 31,
 
     2011     2010  

Home sale revenues

   $ 782,471      $ 976,806   

Land sale revenues

     1,296        12,986   
                

Total Homebuilding revenues

     783,767        989,792   

Home sale cost of revenues (a)

     (685,030     (850,095

Land sale cost of revenues (b)

     (930     (8,998

Selling, general, and administrative expenses (“SG&A”)

     (135,830     (150,865

Equity in (earnings) loss from unconsolidated entities (c)

     1,098        (111

Other income (expense), net (d)

     (3,869     8,441   
                

Income (loss) before income taxes

   $ (40,794   $ (11,836
                

Gross margin from home sales

     12.5     13.0

SG&A as a % of home sale revenues

     17.4     15.4

Active communities at March 31

     800        842   

Unit settlements

     3,141        3,795   

Average selling price

   $ 249      $ 257   

Net new orders (e):

    

Units

     4,345        4,320   

Dollars (f)

   $ 1,094,000      $ 1,091,000   

Backlog at March 31 (e):

    

Units

     5,188        6,456   

Dollars

   $ 1,368,000      $ 1,691,000   

 

(a) Includes homebuilding interest expense, which represents the amortization of capitalized interest. Home sale cost of revenues also includes land and community valuation adjustments of $0.1 million and $4.5 million for the three months ended March 31, 2011 and 2010, respectively.
(b) Includes net realizable value adjustments for land held for sale of $0.6 million for the three months ended March 31, 2010.
(c) Includes impairments of our investments in unconsolidated joint ventures of $1.9 million for the three months ended March 31, 2010.
(d) Includes the write off of deposits and pre-acquisition costs for land option contracts we no longer plan to pursue of $0.6 million and $0.5 million for the three months ended March 31, 2011 and 2010, respectively.
(e) During the three months ended March 31, 2010, we revised our criteria for recognizing new orders to include the additional requirement of customer preliminary loan approval. This change resulted in a reduction of approximately 450 units and $110.0 million in our reported net new orders and backlog in the first quarter of 2010. We reversed this methodology in the fourth quarter of 2010 as the revised process was not providing a significant benefit for either our operations or our customers.
(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.

 

36


Table of Contents

Homebuilding Operations – Summary (continued)

 

The 20% decrease in home sale revenues for the three months ended March 31, 2011 compared with the prior year period was attributable to a 17% decrease in unit settlements combined with a 3% decrease in the average selling price. The decline in unit settlements occurred in each of our Homebuilding segments and resulted primarily from the ongoing housing challenges in the U.S. Additionally, a federal homebuyer tax credit existed during 2010 for orders under contract by April 30 and closed by September 30. This tax credit favorably impacted unit settlements during the first half of 2010, in part by pulling forward customer demand. The 5% decrease in our active communities also contributed to the lower unit settlements. Average selling prices decreased in each of our Homebuilding segments during the three months ended March 31, 2011 compared with the prior year period. This decrease in average selling price reflects a combination of factors but was primarily attributable to shifts in the product and geographic mix of homes closed during the period along with adjusting the product offering in certain communities to better align with current market conditions.

Home sale gross margins were 12.5% for the three months ended March 31, 2011 compared with 13.0% for the same period in the prior year. The lower gross profit margins during 2011 resulted primarily from increased amortization of capitalized interest relative to sales due to the incremental debt assumed with the Centex merger. Gross margins during 2011 benefited from lower land and community valuation adjustments of $0.1 million compared with $4.5 million during 2010. Excluding the impact of land and community valuation adjustments, amortization of capitalized interest, and merger-related costs, home sale gross margins were 16.9% for the three months ended March 31, 2011 compared to 16.3% for the prior year period. This improvement in gross margin reflects a combination of factors, including shifts in the product and geographic mix of homes closed during the year, better alignment of our product offering with current market conditions, and our various initiatives to reduce the construction cost of our homes. (See the Non-GAAP Financial Measure section for reconciliation of home sale gross profit margins, excluding land and community valuation adjustments, amortization of capitalized interest, and merger-related costs, to home sale gross profit margins).

We continue to evaluate our existing land positions to ensure the most effective use of capital. Land sale revenues and their related gains or losses may vary significantly between periods, depending on the timing of land sales. Land sales had positive margin contributions of $0.4 million during the three months ended March 31, 2011, compared with positive margin contributions of $4.0 million during the three months ended March 31, 2010. These margin contributions included net realizable value adjustments related to land held for sale totaling $0.6 million during the three months ended March 31, 2010.

Selling, general, and administrative expense as a percentage of home sale revenues was 17.4% for the three months ended March 31, 2011 compared with 15.4% for the same period in the prior year. While the gross dollar amount of our overall selling, general and administrative costs decreased 10% from the prior year period, it was not enough to compensate for the 20% decline in home sale revenues. Accordingly, our overhead leverage deteriorated. Overall, we have achieved significant reductions in overhead costs in recent years. However, our overhead leverage remains high relative to our sales volumes. In order to further reduce overhead cost and drive greater leverage, we reconfigured our organization during the fourth quarter of 2010, reducing the number of operating areas from six to four and consolidating certain 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. We expect that these changes in our operating structure along with the completion of our integration activities related to the Centex merger will significantly reduce our selling, general, and administrative costs in 2011.

Equity in earnings (loss) from unconsolidated entities was $1.1 million for the three months ended March 31, 2011, and $(0.1) million in the three months ended March 31, 2010. The equity in earnings (loss) experienced during the three months ended March 31, 2010 included impairments related to investments in unconsolidated joint ventures totaling $1.9 million.

Other income (expense), net totaled expense of $3.9 million for the three months ended March 31, 2011 and income of $8.4 million for the three months ended March 31, 2010. This change is due primarily to the favorable resolution of certain contingencies related to old communities in the first quarter of 2010 and unfavorable developments related to certain legal contingencies during the first quarter of 2011. Other income (expense), net also includes the write-off (recovery) of deposits and pre-acquisition costs resulting from decisions not to pursue certain land acquisitions. These write-offs vary in amount from period to period as we continue to evaluate potential land acquisitions for the most effective use of capital and totaled $0.6 million and $0.5 million for the three months ended March 31, 2011 and 2010, respectively.

 

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Table of Contents

Homebuilding Operations – Summary (continued)

 

For the three months ended March 31, 2011, net new order units increased 1% compared with the same period in 2010. After adjusting for the change in policy referenced above in footnote (e) to the summary of pre-tax loss and unit information for our Homebuilding Operations for the three months ended March 31, 2011 and 2010, net new order units declined by 9%. We are encouraged by our net new order levels for the first quarter of 2011, which exceeded our expectations in light of the expiration of the federal homebuyer tax credit during 2010 and the reduced number of active communities. At March 31, 2011 we had 800 active communities, a decrease of 5% from March 31, 2010. The dollar value of net new orders was essentially flat for the three months ended March 31, 2011 compared with the same period in 2010, but declined by 9% after adjusting for the policy change described above. The cancellation rate (cancelled orders for the period divided by gross new orders for the period) for the first quarter of 2011 was 16% compared with 18% for the same period in 2010. Ending backlog, which represents orders for homes that have not yet closed, was 5,188 units with a dollar value of $1.4 billion at March 31, 2011. The 20% decrease in units in backlog compared with March 31, 2010 resulted from the overall decline in volumes in recent quarters.

We had 6,191 and 6,284 homes in production at March 31, 2011 and December 31, 2010, respectively, excluding 1,424 and 1,452 model homes, respectively. Included in our total homes in production were 2,943 and 3,494 homes that were unsold to customers (“spec homes”) at March 31, 2011 and December 31, 2010, respectively, of which 1,539 and 1,856 homes, respectively, were completed (“final specs”).

At March 31, 2011 and December 31, 2010, our Homebuilding operations controlled 144,329 and 147,194 lots, respectively. Of these controlled lots, 129,484 and 131,964 lots were owned and 10,614 and 10,082 lots were under option agreements approved for purchase at March 31, 2011 and December 31, 2010, respectively. In addition, there were 4,231 lots and 5,148 lots under option agreements pending approval at March 31, 2011 and December 31, 2010, respectively. While we are purchasing select land positions where it makes strategic and economic sense to do so, the reduction in lots resulting from unit settlements, land disposition activity, and withdrawals from land option contracts exceeded the number of lots added by new transactions during the three months ended March 31, 2011.

The total purchase price related to land under option for use by our Homebuilding operations at future dates totaled $700.8 million at March 31, 2011. These land option agreements, which may be cancelled at our discretion and may extend over several years, are secured by deposits and pre-acquisition costs totaling $91.3 million, of which $4.2 million is refundable. This balance excludes contingent payment obligations which may or may not become actual obligations to us.

 

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Non-GAAP Financial Measures

This report contains information about our home sale gross profit margins, excluding land and community valuation adjustments, amortization of capitalized interest, and merger-related costs, which is considered a non-GAAP financial measure under the SEC’s rules and should be considered in addition to, rather than as a substitute for, home sale gross margin (which we define as home sale revenues less home cost of revenues) as a measure of our operating performance. Management and our local divisions use this measure 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 it is a relevant and useful measure to investors for evaluating our performance through gross profit generated on homes delivered during a given period 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 any adjustments thereto before comparing our measures to that of such other companies.

The following table sets forth a reconciliation of this non-GAAP financial measure to home sale gross margin, a GAAP financial measure, which management believes to be the GAAP financial measure most directly comparable to this non-GAAP financial measure ($000’s omitted):

 

     Three Months Ended
March 31,
 
     2011     2010  

Home sale revenues

   $ 782,471      $ 976,806   

Home sale cost of revenues

     (685,030     (850,095
                

Home sale gross margin

     97,441        126,711   

Add:

    

Land and community valuation adjustments (a)

     41        3,518   

Capitalized interest amortization (a)

     34,816        27,000   

Merger-related costs (b)

     280        2,444   
                

Home sale gross profit margins, excluding land and community valuation adjustments, amortization of capitalized interest, and merger-related costs

   $ 132,578      $ 159,673   
                

Home sale gross margin as a percentage of home sale revenues

     12.5     13.0

Home sale gross profit margins, excluding land and community valuation adjustments, amortization of capitalized interest, and merger-related costs as a as a percentage of home sales revenues

     16.9     16.3

 

(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 cost of revenues over the related home closings.

 

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Homebuilding Segment Operations

Our homebuilding operations represent our core business. Homebuilding offers a broad product line to meet the needs of first-time, first and second move-up, and active adult homebuyers. We have determined that our operating segments are our Areas. In the fourth quarter of 2010, we realigned the organizational structure for certain of our Areas. The operating data by segment provided below have been reclassified to conform to the current presentation. We conduct our operations in 60 markets, located throughout 28 states, and have presented our reportable Homebuilding segments as follows:

 

East:

   Delaware, Georgia, Maryland, Massachusetts,
   New Jersey, New York, North Carolina, Pennsylvania,
   Rhode Island, South Carolina, Tennessee, Virginia

Gulf Coast:

   Florida, Texas

Central:

   Arizona, Colorado, Illinois, Indiana, Missouri, Michigan,
   Minnesota, New Mexico, Ohio

West:

   California, Hawaii, Nevada, Oregon, Washington

 

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Homebuilding Segment Operations (continued)

 

The following tables present selected financial information for our reportable Homebuilding segments:

 

     Operating Data by Segment ($000’s omitted)  
     Three Months Ended
March 31,
 
     2011     2010  

Home sale revenue (settlements):

    

East

   $ 268,841      $ 358,477   

Gulf Coast

     246,754        251,932   

Central

     146,486        187,146   

West

     120,390        179,251   
                
   $ 782,471      $ 976,806   
                

Income (loss) before income taxes:

    

East

   $ 3,656      $ 14,589   

Gulf Coast

     3,977        (3,398

Central

     (12,315     (436

West

     2,092        10,548   

Other homebuilding

     (38,204     (33,139
                
   $ (40,794   $ (11,836
                

Unit settlements:

    

East

     937        1,221   

Gulf Coast

     1,187        1,251   

Central

     624        771   

West

     393        552   
                
     3,141        3,795   
                

Net new orders - units:

    

East

     1,230        1,191   

Gulf Coast

     1,784        1,551   

Central

     893        991   

West

     438        587   
                
     4,345        4,320   
                

Unit backlog:

    

East

     1,580        2,038   

Gulf Coast

     2,066        2,381   

Central

     1,050        1,205   

West

     492        832   
                
     5,188        6,456   
                

 

     As of
March 31, 2011
     As of
December 31, 2010
 

Controlled lots:

     

East

     32,479         33,821   

Gulf Coast

     52,246         53,783   

Central

     39,204         38,917   

West

     20,400         20,673   
                 
     144,329         147,194   
                 

 

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Homebuilding Segment Operations (continued)

 

East:

For the first quarter of 2011, East home sale revenues decreased 25% compared with the prior year period due to a 23% decrease in unit settlements and a 2% decrease in the average selling price. Gross margin, both including and excluding land-related charges, increased over the prior year period. The decreased income before income taxes was primarily due to the decreased revenues and land-related charges of $0.5 million in the first quarter of 2011. Net new order units increased 3% led by our operations in the Mid-Atlantic and Raleigh. Adjusted for the change in our policy in the first quarter of 2010, net new order units decreased slightly. The cancellation rate was 13% and 16% in the first quarters of 2011 and 2010, respectively.

Gulf Coast:

For the first quarter of 2011, Gulf Coast home sale revenues decreased 2% compared with the prior year period due to a 5% decrease in unit settlements partially offset by a 3% increase in the average selling price. The income before income taxes in the first quarter of 2011 was attributable to higher gross margins (both including and excluding land-related charges), improved overhead leverage, and lower land-related charges. Land-related charges were negligible in the first quarter of 2011, compared with $3.7 million in the prior year period. Net new order units increased by 15% in part due to grand openings or grand re-openings at several large communities in Florida and Houston. Adjusted for the change in our policy in the first quarter of 2010, net new order units increased slightly. The cancellation rate was 18% and 21% in the first quarters of 2011 and 2010, respectively.

Central:

Central home sale revenues decreased 22% during the quarter compared with the prior year period due to a 19% decrease in unit settlements and a 3% decrease in the average selling price. The increased loss before income taxes was due to the decrease in revenues and decreased gross margins (both including and excluding land-related charges) as most of these markets continue to struggle due to the overall weak demand for new housing in the Midwest. Land-related charges were negligible in the first quarter of 2011, compared with $0.5 million in the prior year period. Net new order units decreased by 10%, though the decrease was almost 20% after adjusting for the change in our policy in the first quarter of 2010. The cancellation rate in the first quarter of 2011 was 15% compared with 14% in the same period in 2010.

West:

For the first quarter of 2011, West home sale revenues decreased 33% compared with the prior year period due to a 29% decrease in unit settlements and a 6% decrease in average selling prices. Gross margin, both including and excluding land-related charges, increased over the prior year period. The decreased income before income taxes was primarily due to the decrease in revenues. Land-related charges totaled $0.1 million in the first quarter of 2011, compared with $0.5 million in the prior year period. Net new order units decreased by 25% in the first quarter of 2011 compared with the same period in the prior year, primarily in our California divisions. The sales volumes for our California divisions reflect the impact of the state homebuyer tax credit that existed in California during 2010. The expiration of this tax credit has exacerbated the already challenging local market conditions. The decrease was moderately greater after adjusting for the change in our policy in the first quarter of 2010. The cancellation rate was 20% and 22% in the first quarters of 2011 and 2010, respectively.

 

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Financial Services Operations

We conduct our Financial Services operations, which include mortgage and title operations, through Pulte Mortgage and other subsidiaries. We originate mortgage loans using our own funds or borrowings made available through various credit arrangements, and then sell such mortgage loans monthly to outside investors. Also, we sell our servicing rights on a flow basis through fixed price servicing sales contracts. The following table presents selected financial information for our Financial Services segment ($000’s omitted):

 

     Three Months Ended  
     March 31,  
     2011     2010  

Mortgage operations revenues

   $ 17,558      $ 21,628   

Title services revenues

     3,877        8,938   
                

Total Financial Services revenues

     21,435        30,566   

Expenses

     (20,473     (25,111

Equity in income (loss) from unconsolidated entities

     11        17   
                

Income (loss) before income taxes

   $ 973      $ 5,472   
                

Total originations:

    

Loans

     1,865        2,325   

Principal

   $ 378,000      $ 498,000   

Operating as a captive business model primarily targeted to supporting our Homebuilding operations, the operating results of our Financial Services operations are directly linked to Homebuilding. Since 2007, the mortgage industry experienced a significant shift away from subprime, Alt-A, and high loan-to-value loans brought about by investors’ reluctance to purchase these loans due to their perceived risk. This, among other things, has resulted in an 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 each of the three months ended March 31, 2011 and 2010. Total Financial Services revenues for the three months ended March 31, 2011 decreased 30% compared with the same period in the prior year. The decrease resulted from a 19% decrease in mortgage revenues combined with a 57% decrease in title services revenues. Mortgage revenues declined primarily as the result of the lower Homebuilding unit settlements. Title services revenues declined primarily as the result of the disposal in the second quarter of 2010 of the retail title operations acquired with the Centex merger. The lower Homebuilding revenues also contributed to the decline.

Agency production in both the three months ended March 31, 2011 and 2010 for funded originations was 99%. Within the funded agency originations, FHA loans represented approximately 32% during the three months ended March 31, 2011, compared with 40% in the prior year period. Substantially all loan production in 2011 and 2010 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 have higher servicing values, less competition, and structured guidelines that allow for expense efficiencies when processing the loan.

Our capture rate was 76% and 75% for the three months ended March 31, 2011 and 2010, respectively. Our capture rate represents loan originations from our Homebuilding operations as a percentage of total loan opportunities from our Homebuilding operations, excluding cash settlements. At March 31, 2011, our loan application backlog was $730.1 million, compared with $1.1 billion at March 31, 2010.

Income before income taxes decreased in 2011 compared with 2010 primarily due to the lower origination volumes and related reduction in operating efficiencies.

 

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Financial Services Operations (continued)

 

Because we sell the majority of our loans monthly and retain only limited risk related to the loans we originate, our overall loan losses have historically not been significant. Beginning in 2009, however, we have experienced higher than historical losses on our loans held for investment, repurchased or re-insured loans, and foreclosed properties. The largest source for these losses has been a significant increase in actual and anticipated losses for loans previously originated and sold to investors. Such losses may result from 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. If determined to be at fault, we either repurchase the loans from the investors or reimburse the investors’ losses. We establish liabilities for such anticipated losses based upon, among other things, the level of current and estimated probable future repurchase demands made by investors, our ability to cure the defects identified in the repurchase demands, and the severity of loss upon repurchase. The significant increase in anticipated losses has resulted from the high level of loan defaults and related losses in the mortgage industry and increasing aggressiveness by investors in presenting such claims to us.

The vast majority of losses related to our overall exposure for loans previously originated and sold to investors relate to loans originated in 2006 and 2007 when lending standards were less stringent and borrower fraud is believed to have peaked. Given the volatility in the mortgage industry and the uncertainty regarding the ultimate resolution of these claims it is reasonably possible that future losses may exceed our current estimates. Changes in these liabilities are as follows ($000’s omitted):

 

     Three Months Ended  
     March 31,  
     2011     2010  

Liabilities, beginning of period

   $ 93,057      $ 105,914   

Provision for losses

     —          (354

Settlements

     (10,597     (11,472
                

Liabilities, end of period

   $ 82,460      $ 94,088   
                

Loan loss provisions related to our portfolio loans, real estate owned, and mortgage reinsurance reserves were not significant during the three months ended March 31, 2011 and 2010.

We are exposed to market risks from commitments to lend, movements in interest rates, and cancelled or modified commitments to lend. A commitment to lend at a specific interest rate (an interest rate lock commitment) is a derivative financial instrument (interest rate is locked to the borrower). In order to reduce these risks, we use other derivative financial instruments to economically hedge the interest rate lock commitment. These financial instruments include forward 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. The changes in the fair value of the interest rate lock commitment and the other derivative financial instruments are included in Financial Services revenues. We do not use any derivative financial instruments for trading purposes.

 

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Other Non-Operating

Other non-operating expenses consist of income and expenses related to corporate services provided to our subsidiaries. These expenses are incurred for financing, developing and implementing strategic initiatives centered on new business development and operating efficiencies, and providing the necessary administrative support associated with being a publicly traded entity listed on the New York Stock Exchange. Accordingly, these results will vary from period to period as these strategic initiatives and costs evolve. The following table presents other non-operating expenses for the three months ended March 31, 2011 and 2010 ($000’s omitted):

 

     Three Months Ended  
     March 31,  
     2011     2010  

Net interest income

   $ 1,086      $ 2,297   

Selling, general, and administrative expenses

     (6,616     (10,441

Other income (expenses), net

     (41     —     
                

Income (loss) before income taxes

   $ (5,571   $ (8,144
                

The decrease in net interest income from the prior year period resulted primarily from lower invested cash balances. The decline in selling, general, and administrative expenses from the prior year period resulted primarily from lower compensation costs, partially offset by expense of $1.3 million related to the write-off of unamortized issuance costs associated with the termination of our revolving credit facility in March 2011.

We capitalize interest cost into inventory during the active development and construction of our communities. Each layer of capitalized interest is amortized over a period that approximates the average life of communities under development. Interest expense is allocated over the period based on the cyclical timing of closings. Interest expensed to homebuilding cost of revenues for the three months ended March 31, 2011 includes $0.1 million of capitalized interest related to land and community valuation adjustments compared with $1.0 million for the three months ended March 31, 2010. During the three months ended March 31, 2011 and 2010, we capitalized all of our Homebuilding interest costs into inventory because the level of our active inventory exceeded our debt levels.

Information related to interest capitalized into homebuilding inventory is as follows ($000’s omitted):

 

     Three Months Ended  
     March 31,  
     2011     2010  

Interest in inventory, beginning of period

   $ 323,379      $ 239,365   

Interest capitalized

     56,191        68,896   

Interest expensed

     (34,816     (27,000
                

Interest in inventory, end of period

   $ 344,754      $ 281,261   
                

Interest incurred*

   $ 56,191      $ 68,896   
                

 

* Interest incurred includes interest on our senior debt, short-term borrowings, and other financing arrangements and excludes interest incurred by our Financial Services segment and certain other interest costs.

Income Taxes

Our income tax assets and liabilities and related effective tax rate are affected by a number of factors, the most significant of which is the valuation allowance recorded against our deferred tax assets. Due to the effect of our valuation allowance, our effective tax rates for the three months ended March 31, 2011 and 2010 are not meaningful as our income tax benefit is not directly correlated to the amount of our pretax loss. Income taxes were provided at an effective tax rate of 12.9% for the three months ended March 31, 2011, compared with an effective tax rate of 13.9% for the prior year period. The income tax benefit for the three months ended March 31, 2011 and 2010 resulted primarily from the favorable resolution of certain income tax matters.

 

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Liquidity and Capital Resources

We finance our land acquisition, development, and construction activities by using internally-generated funds and existing credit arrangements. We routinely monitor current and expected operational requirements and financial market conditions to evaluate the use of available financing sources, including securities offerings. Based on our current financial condition and credit relationships, we believe that our operations and borrowing resources are sufficient to provide for our current and foreseeable capital requirements. However, we continue to evaluate the impact of market conditions on our liquidity and may determine that modifications are appropriate if market conditions deteriorate or if the current difficult market conditions extend beyond our expectations.

At March 31, 2011, we had cash and equivalents of $1.3 billion and $3.4 billion of senior notes outstanding. We also had restricted cash balances of $133.4 million, the substantial majority of which related to cash serving as collateral under certain letter of credit facilities. Other financing sources included limited recourse land-collateralized financing totaling $1.2 million and our various letter of credit facilities. An additional source of liquidity during 2010 was the receipt of federal tax refunds, which resulted primarily from the carryback of taxable losses provided by 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, given the volatility in the global financial markets, there can be no assurances that losses of principal balance on our cash and equivalents will not occur.

Our ratio of debt to total capitalization, excluding our land-collateralized debt, was 61.7% at March 31, 2011, and 48.2% 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.

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 March 31, 2011, $153.0 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, though 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, rather than continue to maintain the Credit Facility; and we expect to utilize such agreements in the future as well as the $200.0 million unsecured letter of credit facility discussed in the above paragraph. The termination of the Credit Facility released the $250.0 million of cash that we were required by the Credit Facility to maintain in liquidity reserve accounts. The termination of the Credit Facility also released the Company from the Credit Facility’s covenant requirements, which included, among other things, a maximum debt to tangible capital ratio and a tangible net worth minimum.

In connection with the termination of the Credit Facility, the Company entered into separate cash-collateralized letter of credit agreements with a number of different financial institutions. These agreements provide capacity to issue letters of credit totaling up to $192.0 million, of which $109.7 million was outstanding at March 31, 2011. Under these agreements, the Company is required to maintain deposits with these financial institutions in amounts approximating the letters of credit outstanding. Such deposits totaled $109.7 million at March 31, 2011 and are included in restricted cash on the Consolidated Balance Sheet.

Pulte Mortgage provides mortgage financing for many of our home sales and uses its own funds and borrowings made available pursuant to certain third party and intercompany borrowings. Pulte Mortgage uses these resources to finance its lending activities until the mortgage loans are sold to third party investors, generally within 30 days. Given our strong liquidity 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. At March 31, 2011, we elected to fund $35.5 million of Pulte Mortgage’s financing needs via a repurchase agreement with the Company.

 

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Liquidity and Capital Resources (continued)

 

Pursuant to the two $100 million stock repurchase programs authorized by our Board of Directors in October 2002 and 2005, and the $200 million stock repurchase authorization in February 2006 (for a total stock repurchase authorization of $400 million), we have repurchased a total of 9,688,900 shares for a total of $297.7 million. There have been no repurchases under these programs since 2006. We had remaining authorization to purchase common stock aggregating $102.3 million at March 31, 2011.

In recent years, we have generated significant positive cash flow primarily through the liquidation of land inventory without a corresponding level of reinvestment combined with refunds of income taxes paid in prior years. We have used this positive cash flow to, among other things, increase our cash reserves as well as retire outstanding debt. However, we do not anticipate that we will be able to continue to generate positive cash flow at these same levels in the near future. Additionally, should growth conditions return to the homebuilding industry, we will need to invest significant capital into our operations to support such growth.

Our net cash used in operating activities for the three months ended March 31, 2011 was $159.0 million, compared with net cash provided by operating activities of $677.6 million for the three months ended March 31, 2010. Generally, the primary drivers of cash flow from operations are inventory levels and profitability. Our negative cash flow is primarily the result of our net loss from operations combined with the $109.7 million of restricted cash we are now required to maintain related to our new letter of credit facilities and using internal funds to finance Pulte Mortgage’s lending operations. Cash flows were impacted by a net increase in inventories of $11.0 million during the three months ended March 31, 2011 compared with a net increase in inventories of $100.5 million during the three months ended March 31, 2010. In addition, during the three months ended March 31, 2011, we received income tax refunds of $2.9 million compared with $786.2 million during the prior year period.

Net cash used in investing activities was $4.4 million for the three months ended March 31, 2011, compared with $0.7 million for the three months ended March 31, 2010. The increase is primarily due to capital expenditures.

Net cash used in financing activities totaled $14.3 million for the three months ended March 31, 2011, primarily due to the retirement of $13.9 million of senior notes at their scheduled maturity date. Net cash provided by financing activities for the three months ended March 31, 2010 totaled $46.5 million, primarily as the result of borrowings under our Financial Services credit arrangements.

Inflation

We, and the homebuilding industry in general, may be adversely affected during periods of high inflation because of higher land and construction costs. Inflation may also increase our financing, labor, and material costs. In addition, higher mortgage interest rates significantly affect the affordability of permanent mortgage financing to prospective homebuyers. While we attempt to pass on to our customers increases in our costs through increased sales prices, the current industry conditions have resulted in lower sales prices in many of our markets. If we are unable to raise sales prices enough to compensate for higher costs, or if mortgage interest rates increase significantly, affecting our prospective homebuyers’ ability to adequately finance home purchases, our revenues, gross margins, and net income would be adversely affected.

Seasonality

We experience variability in our quarterly results from operations due to the seasonal nature of the homebuilding industry. Historically, we have experienced significant increases in revenues and cash flow from operations during the fourth quarter based on the timing of home settlements. Under current market conditions, however, it is difficult to determine whether these seasonal trends will continue.

Contractual Obligations

There have been no material changes to our contractual obligations from those disclosed in our “Contractual Obligations” contained in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the year ended December 31, 2010.

 

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Off-Balance Sheet Arrangements

At March 31, 2011 and December 31, 2010, aggregate outstanding debt of unconsolidated joint ventures was $14.3 million and $15.5 million, respectively, of which our proportionate share of such joint venture debt was $4.5 million and $5.1 million, respectively. Of our proportionate share of joint venture debt, we provided limited recourse guaranties of $1.4 million for such joint venture debt at both March 31, 2011 and December 31, 2010. See Note 6 to the Consolidated Financial Statements included elsewhere in this Form 10-Q for additional information.

Critical Accounting Policies and Estimates

There have been no significant changes to our critical accounting policies and estimates during the three months ended March 31, 2011 compared with those contained in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, included in our Annual Report on Form 10-K for the year ended December 31, 2010.

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Quantitative disclosure:

We are subject to interest rate risk on our rate-sensitive financing to the extent long-term rates decline. The following table sets forth, as of March 31, 2011, our rate-sensitive financing obligations, principal cash flows by scheduled maturity, weighted-average interest rates, and estimated fair values ($000’s omitted):

 

    As of March 31, 2011 for the
years ending December 31,
 
    2011     2012     2013     2014     2015     Thereafter     Total     Fair
Value
 

Rate-sensitive liabilities:

               

Fixed interest rate debt:

               

Senior notes

  $ —        $ 103,699      $ 227,911      $ 654,590      $ 669,491      $ 1,780,000      $ 3,435,691      $ 3,279,168   

Average interest rate

    0.00     5.45     5.43     5.47     5.23     6.79     6.10  

Limited recourse collateralized financing

  $ 1,150      $ —        $ —        $ —        $ —        $ —        $ 1,150      $ 1,150   

Average interest rate

    6.50     0.00     0.00     0.00     0.00     0.00     6.50  

Qualitative disclosure:

There has been no material change to the qualitative disclosure found in Item 7A., Quantitative and Qualitative Disclosures about Market Risk, of our Annual Report on Form 10-K for the year ended December 31, 2010.

 

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Special Notes Concerning Forward-Looking Statements

As a cautionary note, except for the historical information contained herein, certain matters discussed in Item 2, Management’s Discussion and Analysis of Financial Condition and Results of Operations, and Item 3, Quantitative and Qualitative Disclosures About Market Risk, are “forward-looking” statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statem