Item 2. Management’s Discussion and Analysis
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
We continue to experience strong demand for our products as new orders increased 12% over the prior year for the nine months ended September 30, 2021. While new orders were 17% lower than the prior year for the three months ended September 30, 2021, the decrease was driven primarily by a 14% reduction in community count in combination with Company actions to strategically manage the pace of sales to better align with current production levels. The favorable demand for new housing has been driven by mortgage interest rates near historical lows, a limited supply of new and existing home inventory, an increased appeal for homeownership and single-family living, and a desire among some buyers to exit more densely populated urban centers or to relocate from higher cost geographical regions. As a result, our order backlog increased 33% in units and 56% in dollars as of September 30, 2021 over the prior year.
Home closings increased 9% and 14% in the three and nine months ended September 30, 2021, respectively, compared with the prior year periods. The higher closing volume is despite significant disruption in the homebuilding supply chain, including the availability of certain materials and construction labor combined with delays in municipal approvals and inspections, which has elongated the production cycle of the homes we are constructing. While we are working with our supply partners, have increased our speculative housing starts, and have hired additional construction and customer service employees, our production cycle times have extended in the majority of our markets due to the challenges referenced above. Due to these supply chain challenges, we are moderating lot releases and the pace of new orders in the majority of our communities in order to balance sales volume and production capacity to reduce backlog durations. We believe these conditions will continue to impact our industry for at least the next few quarters.
We are also facing cost pressures related to labor and materials, due in large part to a shortage of workers and supply chain challenges resulting from ongoing effects of the COVID-19 pandemic and other macroeconomic factors. Specifically, the cost of lumber more than quadrupled from mid-2020 to mid-2021. While the cost of lumber has declined significantly since peaking in May 2021, it remains elevated compared to historical norms, and the availability of certain wood products, including roof and floor trusses and oriented strand boards, remains challenged. We also continue to experience significant challenges with the cost and availability of windows, siding, and appliances, among other supply categories. To date, we have been, and believe we will continue to be, able to increase pricing to offset the majority of such cost increases due to ongoing high consumer demand.
Despite the development of vaccines and more effective treatments for the physical impacts of COVID-19, there are no reliable estimates of how long the COVID-19 pandemic, or its related impacts on overall economic conditions or the global supply chain, will last. As a result, the unpredictability of the current economic and public health conditions will continue to evolve. However, all of our operations continue to function at effectively full capacity subject to health and safety protocols, and we remain optimistic about future housing demand and our ability to continue expanding our business. Due to the higher demand and long municipal entitlement timelines, the number of our active communities continues to decrease as we close communities at a pace faster than we are opening new ones. While we have increased our investments in land acquisition and development, we expect that the number of our active communities will not begin to increase meaningfully until 2022.
Consolidated Operations
The following is a summary of our operating results by line of business ($000's omitted, except per share data):
Three Months Ended Nine Months Ended
September 30, September 30,
2021 2020 2021 2020
Income before income taxes:
Homebuilding $ 571,763 $ 420,103 $ 1,487,486 $ 1,060,906
Financial Services 48,639 64,064 166,442 144,038
Income before income taxes 620,402 484,167 1,653,928 1,204,944
Income tax expense (144,853) (67,769) (370,873) (236,216)
Net income $ 475,549 $ 416,398 $ 1,283,055 $ 968,728
Per share data - assuming dilution:
Net income $ 1.82 $ 1.54 $ 4.85 $ 3.56
• Homebuilding income before income taxes for the three and nine months ended September 30, 2021 increased 36% and 40%, respectively, compared with the same periods in 2020, respectively. The results are primarily the result of increased closings, higher gross margins, and improved overhead leverage in 2021. The results also include
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insurance adjustments of $53.7 million for the nine months ended September 30, 2021, compared to $59.4 million for the nine months ended September 30, 2020 (see Note 8 ). This benefit in 2020 was partially offset by severance expense of $10.4 million for the nine months ended September 30, 2020, and a goodwill impairment charge totaling $20.2 million ( see Note 1 ) in the nine months ended September 30, 2020. Results for the nine months ended September 30, 2021 also include a loss on debt retirement of $61.5 million (see Note 4 ).
• Financial Services income before income taxes for the three months ended September 30, 2021 decreased 24% compared to the same period in 2020, primarily as a result of increased competition in 2021 resulting in lower revenue per loan. For the nine months ended September 30, 2021, Financial Services income before income taxes increased 16% compared with the same period in 2020 as a result of higher volumes, which largely resulted from increased homebuilding volumes, partially offset by the lower revenue per loan.
• Our effective tax rate for the three and nine months ended September 30, 2021 was 23.3% and 22.4%, respectively, compared to 14.0% and 19.6%, respectively, for the same periods in 2020. Our effective tax rate for each of these periods differs from the federal statutory rate primarily due to state income tax expense and benefits associated with federal energy efficient home credits. Income tax expense in the three and nine months ended September 30, 2020 includes benefits of $53.2 million and $58.0 million, respectively, associated with the extension of federal energy efficient homes tax credits, including to homes closed in prior open tax years. The effective tax rate for the nine months ended September 30, 2021 also reflects a reduction in valuation allowances relating to projected utilization of certain state net operating loss carryforwards.
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Homebuilding Operations
The following presents selected financial information for our Homebuilding operations ($000’s omitted):
Three Months Ended Nine Months Ended
September 30, September 30,
2021 2021 vs. 2020 2020 2021 2021 vs. 2020 2020
Home sale revenues $ 3,324,483 18 % $ 2,823,921 $ 9,156,371 22 % $ 7,517,453
Land sale and other revenues 63,085 161 % 24,165 123,321 76 % 70,042
Total Homebuilding revenues 3,387,568 19 % 2,848,086 9,279,692 22 % 7,587,495
Home sale cost of revenues (a)
(2,443,074) 15 % (2,131,741) (6,754,204) 18 % (5,706,814)
Land sale and other cost of revenues (47,483) 132 % (20,502) (103,313) 86 % (55,558)
Selling, general, and administrative
expenses ("SG&A") (b)
(320,506) 18 % (271,257) (864,478) 18 % (731,785)
Loss on debt retirement — (c) — (61,469) (c) —
Goodwill impairment — (c) — — (c) (20,190)
Other expense, net (4,742) 6 % (4,483) (8,742) (29) % (12,242)
Income before income taxes $ 571,763 36 % $ 420,103 $ 1,487,486 40 % $ 1,060,906
Supplemental data:
Gross margin from home sales 26.5 % 200 bps 24.5 % 26.2 % 210 bps 24.1 %
SG&A as a percentage of home
sale revenues 9.6 % — 9.6 % 9.4 % (30) bps 9.7 %
Closings (units) 7,007 9 % 6,454 20,283 14 % 17,764
Average selling price $ 474 8 % $ 438 $ 451 7 % $ 423
Net new orders (d) :
Units 6,796 (17) % 8,202 24,970 12 % 22,219
Dollars $ 3,780,354 4 % $ 3,634,158 $ 12,668,805 32 % $ 9,579,982
Cancellation rate 10 % 12 % 8 % 15 %
Average active communities 768 (14) % 892 804 (9) % 884
Backlog at September:
Units 19,845 33 % 14,962
Dollars $ 10,305,614 56 % $ 6,598,334
(a) Includes the amortization of capitalized interest.
(b) Includes insurance adjustments of $53.7 million and $59.4 million in the nine months ended September 30, 2021 and 2020, respectively (see Note 8 ), and severance expense of $10.4 million in the nine months ended September 30, 2020.
(c) Percentage not meaningful.
(d) 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.
Home sale revenues
Home sale revenues for the three and nine months ended September 30, 2021 were higher than the prior year periods by $500.6 million and $1.6 billion, respectively. For the three months ended September 30, 2021, the 18% increase was attributable to a 9% increase in closings combined with an 8% increase in average selling price. For the nine months ended September 30, 2021, the 22% increase was attributable to a 14% increase in closings combined with a 7% increase in average selling price. The increase in closings was primarily the result of favorable demand conditions, including a large backlog of orders. Beginning in March 2020, the COVID-19 pandemic began to unfavorably impact the demand environment. However, demand improved significantly beginning in June 2020 and has remained favorable. The higher average selling price reflects the impact
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of pricing actions taken in response to the higher demand as well as increased input costs, partially offset by a small increase in the mix of first-time buyer homes, which typically carry a lower sales price.
Home sale gross margins
Home sale gross margins were 26.5% and 26.2% for the three and nine months ended September 30, 2021, respectively, compared to 24.5% and 24.1% for the three and nine months ended September 30, 2020, respectively. Gross margins for the three and nine months ended September 30, 2021 remained higher than prior year levels and reflect a combination of factors, including: strong consumer demand, the low mortgage interest rate environment, and limited supplies of new and existing housing inventory. As a result, the pricing environment remains strong, which has allowed us to effectively manage pressure in house and land costs through pricing actions. While costs remain elevated, we have been able to more than offset these cost increases through price increases. Additionally, while speculative home sales (homes started prior to receipt of a customer order) remain the minority of our operations, the current environment is providing opportunities for additional pricing and relative margin gains related to such homes.
Land sale and other revenues
We periodically elect to sell parcels of land to third parties in the event such assets no longer fit into our strategic operating plans or are zoned for commercial or other development. Land sale and other revenues and their related gains or losses vary between periods, depending on the timing of land sales and our strategic operating decisions. Land sales and other revenues contributed income of $15.6 million and $20.0 million for the three and nine months ended September 30, 2021, respectively, compared to $3.7 million and $14.5 million for the three and nine months ended September 30, 2020, respectively. Income in the three and nine months ended September 30, 2021 included a gain of $12.9 million related to a land sale transaction in California that had been in the entitlement process for a number of years.
SG&A
SG&A as a percentage of home sale revenues was 9.6% and 9.4% for the three and nine months ended September 30, 2021, respectively, compared with 9.6% and 9.7% for the three and nine months ended September 30, 2020, respectively. The gross dollar amount of our SG&A increased $49.2 million, or 18%, for the three months ended September 30, 2021 compared to September 30, 2020, and increased $132.7 million, or 18%, for the nine months ended September 30, 2021 compared to September 30, 2020. The change in gross dollars in 2021 resulted from the higher production volume primarily as the result of higher sales commissions expense. The improvement in year-to-date SG&A as a percentage of home sale revenues is primarily attributable to leverage gained from the higher revenues. This overhead leverage was partially offset in 2021 by higher headcount to support the increased production volume as well as higher incentive compensation accruals due to the Company's strong operating performance. The nine months ended September 30, 2020 also included severance expense of $10.3 million as we took actions in the second quarter of 2020 to reduce overhead expenses due to the disruption caused by the early stages of the COVID-19 pandemic.
Other expense, net
Other expense, net includes the following ($000’s omitted):
Three Months Ended Nine Months Ended
September 30, September 30,
2021 2020 2021 2020
Write-offs of deposits and pre-acquisition costs $ (3,567) $ (1,692) $ (6,801) $ (8,335)
Amortization of intangible assets (3,612) (5,041) (13,571) (14,643)
Interest income 436 891 1,541 6,024
Interest expense (115) (225) (387) (4,022)
Equity in earnings of unconsolidated entities 604 336 5,620 1,238
Miscellaneous, net 1,512 1,248 4,856 7,496
Total other expense, net $ (4,742) $ (4,483) $ (8,742) $ (12,242)
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Net new orders
Net new orders in units decreased 17% while net new orders in dollars increased 4% for the three months ended September 30, 2021 as compared with the prior year period. Net new orders in units increased 12% while net new orders in dollars increased 32% for the nine months ended September 30, 2021 as compared with the prior year period. The net new order volume in 2021 reflects favorable demand conditions partially offset by a lower community count, as more fully discussed above. The cancellation rate (canceled orders for the period divided by gross new orders for the period) was 10% and 8% for the three and nine months ended September 30, 2021, respectively, and 12% and 15% for the same periods in 2020. Ending backlog dollars, which represents orders for homes that have not yet closed, increased 56% at September 30, 2021 compared with September 30, 2020.
Homes in production
The following is a summary of our homes in production:
September 30,
2021 September 30,
2020
Sold 15,676 9,696
Unsold
Under construction 3,017 1,405
Completed 109 350
3,126 1,755
Models 1,212 1,277
Total 20,014 12,728
The number of homes in production at September 30, 2021 was 57% higher than at September 30, 2020. The increase in homes under production is the result of the significant increase in demand, coupled with elongated cycle times due to supply chain delays for certain materials and labor and obtaining necessary approvals, permits, and inspections from local municipalities. The higher level of unsold homes, or speculative homes, under construction reflects a conscious decision to increase our housing starts of speculative units in response to the noted supply chain challenges and to meet demand. The lower unsold completed inventory reflects our ability to sell these speculative units given the strong demand environment.
Controlled lots
The following is a summary of our lots under control at September 30, 2021 and December 31, 2020:
September 30, 2021 December 31, 2020
Owned Optioned Controlled Owned Optioned Controlled
Northeast 4,739 7,305 12,044 4,956 4,001 8,957
Southeast 15,621 25,803 41,424 15,051 18,248 33,299
Florida 23,135 34,813 57,948 20,737 24,396 45,133
Midwest 12,186 17,294 29,480 9,728 14,734 24,462
Texas 19,267 20,606 39,873 15,923 17,841 33,764
West 27,882 13,973 41,855 24,968 9,769 34,737
Total 102,830 119,794 222,624 91,363 88,989 180,352
Developed (%) 38 % 14 % 25 % 43 % 16 % 30 %
While competition for well-positioned land is robust, we continue to pursue land investments that we believe can achieve appropriate risk-adjusted returns on invested capital and have increased our controlled lot count as the result of the strong demand environment. Additionally, we continue to seek to increase the percentage of our lots that are controlled via land option agreement. Such contracts enable us to defer acquiring portions of properties owned by third parties or unconsolidated entities until we have determined whether and when to exercise our option, which reduces our financial risks associated with long-term land holdings. The remaining purchase price under our land option agreements totaled $5.3 billion at September 30, 2021.
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These land option agreements generally may be canceled at our discretion and in certain cases extend over several years. Our maximum exposure related to these land option agreements is generally limited to our deposits and pre-acquisition costs, which totaled $354.3 million, of which $19.4 million is refundable, at September 30, 2021.
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Homebuilding Segment Operations
As of September 30, 2021, we conducted our operations in 40 markets located throughout 23 states. For reporting purposes, our Homebuilding operations are aggregated into six reportable segments:
Northeast: Connecticut, Maryland, Massachusetts, New Jersey, Pennsylvania, Virginia
Southeast: Georgia, North Carolina, South Carolina, Tennessee
Florida: Florida
Midwest: Illinois, Indiana, Kentucky, Michigan, Minnesota, Ohio
Texas: Texas
West: Arizona, California, Nevada, New Mexico, Washington
The following tables present selected financial information for our reportable Homebuilding segments:
Operating Data by Segment ($000's omitted)
Three Months Ended Nine Months Ended
September 30, September 30,
2021 2021 vs. 2020 2020 2021 2021 vs. 2020 2020
Home sale revenues:
Northeast $ 273,206 13 % $ 242,758 $ 735,418 35 % $ 546,437
Southeast 587,292 36 % 432,072 1,539,928 21 % 1,271,001
Florida 707,990 17 % 605,731 2,072,344 25 % 1,655,034
Midwest 504,273 23 % 410,384 1,332,407 28 % 1,039,114
Texas 412,201 15 % 358,177 1,255,377 18 % 1,067,681
West 839,521 8 % 774,799 2,220,897 15 % 1,938,186
$ 3,324,483 18 % $ 2,823,921 $ 9,156,371 22 % $ 7,517,453
Income (loss) before income taxes (a) :
Northeast $ 53,410 35 % $ 39,442 $ 132,604 72 % $ 76,995
Southeast 109,407 58 % 69,275 274,174 39 % 196,798
Florida (b)
133,642 26 % 106,394 382,682 48 % 258,991
Midwest 72,537 16 % 62,638 196,205 42 % 137,707
Texas 71,062 10 % 64,646 221,099 24 % 178,150
West 173,137 42 % 121,974 403,039 44 % 279,393
Other homebuilding (c)
(41,432) (6) % (44,266) (122,317) (82) % (67,128)
$ 571,763 36 % $ 420,103 $ 1,487,486 40 % $ 1,060,906
(a) Includes land-related charges as summarized in the table below.
(b) Includes goodwill impairment charge totaling $20.2 million in the nine months ended September 30, 2020.
(c) Other homebuilding includes the amortization of intangible assets and capitalized interest and other items not allocated to the operating segments. Other homebuilding also includes insurance adjustments of $53.7 million and $59.4 million in the nine months ended September 30, 2021 and 2020, respectively (see Note 8 ). Other homebuilding also includes a loss on debt retirement of $61.5 million in the nine months ended September 30, 2021 (see Note 4 ).
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Operating Data by Segment ($000's omitted)
Three Months Ended Nine Months Ended
September 30, September 30,
2021 2021 vs. 2020 2020 2021 2021 vs. 2020 2020
Closings (units):
Northeast 472 10 % 428 1,286 29 % 998
Southeast 1,278 21 % 1,057 3,507 14 % 3,089
Florida 1,502 5 % 1,427 4,614 15 % 4,017
Midwest 1,123 18 % 950 3,004 22 % 2,466
Texas 1,276 10 % 1,162 4,020 15 % 3,484
West 1,356 (5) % 1,430 3,852 4 % 3,710
7,007 9 % 6,454 20,283 14 % 17,764
Average selling price:
Northeast $ 579 2 % $ 567 $ 572 4 % $ 548
Southeast 460 12 % 409 439 7 % 411
Florida 471 11 % 424 449 9 % 412
Midwest 449 4 % 432 444 5 % 421
Texas 323 5 % 308 312 2 % 306
West 619 14 % 542 577 10 % 522
$ 474 8 % $ 438 $ 451 7 % $ 423
Net new orders - units:
Northeast 368 (38) % 591 1,451 2 % 1,422
Southeast 1,085 (14) % 1,255 4,010 15 % 3,491
Florida 1,844 (1) % 1,868 6,451 28 % 5,041
Midwest 1,075 (14) % 1,243 3,936 25 % 3,158
Texas 1,117 (33) % 1,673 4,468 (3) % 4,613
West 1,307 (17) % 1,572 4,654 4 % 4,494
6,796 (17) % 8,202 24,970 12 % 22,219
Net new orders - dollars:
Northeast $ 221,016 (34) % $ 336,514 $ 864,079 9 % $ 796,058
Southeast 588,400 11 % 529,037 1,966,434 35 % 1,452,429
Florida 1,043,871 30 % 803,858 3,308,173 58 % 2,093,957
Midwest 538,621 (2) % 550,500 1,856,704 36 % 1,370,247
Texas 463,727 (10) % 515,721 1,655,023 19 % 1,389,186
West 924,719 3 % 898,528 3,018,392 22 % 2,478,105
$ 3,780,354 4 % $ 3,634,158 $ 12,668,805 32 % $ 9,579,982
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Operating Data by Segment ($000's omitted)
Three Months Ended Nine Months Ended
September 30, September 30,
2021 2021 vs. 2020 2020 2021 2021 vs. 2020 2020
Cancellation rates:
Northeast 9 % 7 % 7 % 10 %
Southeast 6 % 7 % 6 % 11 %
Florida 8 % 12 % 7 % 14 %
Midwest 7 % 8 % 6 % 11 %
Texas 16 % 15 % 12 % 18 %
West 13 % 18 % 11 % 19 %
10 % 12 % 8 % 15 %
Unit backlog:
Northeast 1,118 10 % 1,013
Southeast 2,843 25 % 2,267
Florida 5,491 65 % 3,330
Midwest 3,131 40 % 2,232
Texas 3,501 18 % 2,979
West 3,761 20 % 3,141
19,845 33 % 14,962
Backlog dollars:
Northeast $ 689,984 16 % $ 597,318
Southeast 1,457,415 51 % 964,896
Florida 2,863,695 102 % 1,417,185
Midwest 1,514,932 54 % 983,110
Texas 1,380,737 51 % 912,372
West 2,398,851 39 % 1,723,453
$ 10,305,614 56 % $ 6,598,334
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Operating Data by Segment
($000’s omitted)
Three Months Ended Nine Months Ended
September 30, September 30,
2021 2020 2021 2020
Land-related charges (a) :
Northeast $ 223 $ 419 $ 357 $ 5,264
Southeast 1,915 725 3,253 2,401
Florida 209 108 642 1,089
Midwest 477 190 969 1,466
Texas 141 82 932 1,068
West 602 170 667 1,844
Other homebuilding — 54 — 798
$ 3,567 $ 1,748 $ 6,820 $ 13,930
(a) Land-related charges include land inventory impairments, net realizable value adjustments on land held for sale, and write-offs of deposits and pre-acquisition costs for land option contracts we elected not to pursue. Other homebuilding consists primarily of write-offs of capitalized interest related to such land-related charges.
Northeast
For the third quarter of 2021, Northeast home sale revenues increased by 13% when compared with the prior year period due to a 10% increase in closings combined with a 2% increase in average selling price. The increase in closings occurred across all markets, while the increase in average selling price was mixed among markets. Income before income taxes increased 35% primarily due to increased revenues, as well as improved gross margins and overhead management which occurred across the majority of markets. Net new orders decreased across the majority of markets.
For the nine months ended September 30, 2021, Northeast home sale revenues increased by 35% when compared with the prior year period due to a 29% increase in closings combined with a 4% increase in average selling price. The increase in closings and average selling price occurred across the majority of markets. Income before income taxes increased 72% primarily due to increased revenues, as well as improved gross margins which occurred across all markets and improved overhead management which occurred across the majority of markets. Net new orders increased across the majority of markets.
Southeast
For the third quarter of 2021, Southeast home sale revenues increased 36% compared with the prior year period as the result of a 21% increase in closings combined with a 12% increase in average selling price. The increase in closings occurred across the majority of markets, while the increase in average selling price occurred across all markets. Income before income taxes increased 58% primarily due to increased revenues, as well as improved gross margins and improved overhead management which occurred across the majority of markets. Net new orders decreased across all markets.
For the nine months ended September 30, 2021, Southeast home sale revenues increased 21% compared with the prior year period as the result of a 14% increase in closings combined with a 7% increase in average selling price. The increase in closings and average selling price occurred across all markets. Income before income taxes increased 39% primarily due to increased revenues, as well as improved gross margins which occurred across the majority of markets. Net new orders increased across all markets.
Florida
For the third quarter of 2021, Florida home sale revenues increased 17% compared with the prior year period due to a 5% increase in closings combined with an 11% increase in the average selling price. The increase in closings occurred across the majority of markets, while the increase in average selling price occurred across all markets. Income before income taxes increased 26% primarily due to increased revenues, as well as improved gross margins and improved overhead management which occurred across the majority of markets. Net new orders decreased across all markets except North Florida.
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For the nine months ended September 30, 2021, Florida home sale revenues increased 25% compared with the prior year period due to a 15% increase in closings combined with an 9% increase in the average selling price. The increase in closings and average selling price occurred across all markets. Income before income taxes increased 48% primarily due to increased revenues, as well as improved gross margins and improved overhead management which occurred across all markets, combined with the impact of a goodwill impairment charge of $20.2 million in the nine months ended September 30, 2020 (see Note 1 ). Net new orders increased across all markets.
Midwest
For the third quarter of 2021, Midwest home sale revenues increased 23% compared with the prior year period due to a 18% increase in closings combined with a 4% increase in average selling price. The increase in closings occurred across all markets, while the increase in average selling price occurred across the majority of markets. Income before income taxes increased 16% primarily due to increased revenues, as well as improved gross margins and improved overhead management which occurred across the majority of markets. Net new orders decreased across the majority of markets.
For the nine months ended September 30, 2021, Midwest home sale revenues increased 28% compared with the prior year period due to a 22% increase in closings combined with a 5% increase in average selling price. The increase in closings occurred across all markets, while the increase in average selling price occurred across the majority of markets. Income before income taxes increased 42% primarily due to increased revenues as well as improved gross margins which occurred the majority of markets. Net new orders increased across all markets.
Texas
For the third quarter of 2021, Texas home sale revenues increased 15% compared with the prior year period due to a 10% increase in closings combined with a 5% increase in average selling price. The increase in closings and average selling price occurred across the majority of markets. Income before income taxes increased 10% primarily due to increased revenues, as well as improved gross margins and improved overhead management which occurred across the majority of markets. Net new orders decreased across all markets.
For the nine months ended September 30, 2021, Texas home sale revenues increased 18% compared with the prior year period due to a 15% increase in closings combined with a 2% increase in the average selling price. The increase in closings occurred across the majority of markets, while the increase in average selling price occurred in all markets. Income before income taxes increased 24% primarily due to increased revenues, as well as improved gross margins and improved overhead management, which occurred across the majority of markets. Net new orders decreased across all markets except Dallas and Austin.
West
For the third quarter of 2021, West home sale revenues increased 8% compared with the prior year period due to a 14% increase in average selling price partially offset by a 5% decrease in closings. The decrease in closings occurred across the majority of markets, while the increase in average selling price occurred across the majority of markets. Income before income taxes increased 42% primarily due to increased revenues, improved overhead management and gross margins across the majority of markets, and gains of $12.9 million related to a land sale transaction in California . Net new orders decreased across the majority of markets.
For the nine months ended September 30, 2021, West home sale revenues increased 15% compared with the prior year period due to a 4% increase in closings combined with an 10% increase in average selling price. The increase in closings and average selling price occurred across the majority of markets. Income before income taxes increased 44% primarily due to increased revenues, improved overhead management and gross margins across all markets, and gains of $12.9 million related to a land sale transaction in California. Net new orders increased across the majority of markets.
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Financial Services Operations
We conduct our Financial Services operations, which include mortgage banking, title, and insurance brokerage operations, through Pulte Mortgage LLC ("Pulte Mortgage") and other subsidiaries. In originating mortgage loans, we initially use our own funds, including funds available pursuant to credit agreements with third parties. Substantially all of the loans we originate are sold in the secondary market within a short period of time after origination, generally within 30 days. We also sell the servicing rights for the loans we originate through fixed price servicing sales contracts to reduce the risks and costs inherent in servicing loans. This strategy results in owning loans and related servicing rights for only a short period of time. Operating as a captive business model primarily targeted to support our Homebuilding operations, the business levels of our Financial Services operations are highly correlated to Homebuilding as Homebuilding customers continue to account for substantially all of its business. We believe that our mortgage capture rate, which represents loan originations from our Homebuilding operations as a percentage of total loan opportunities, excluding cash closings, from our Homebuilding operations is an important metric in evaluating the effectiveness of our captive mortgage business model. The following tables present selected financial information for our Financial Services operations ($000's omitted):
Three Months Ended Nine Months Ended
September 30, September 30,
2021 2021 vs. 2020 2020 2021 2021 vs. 2020 2020
Mortgage revenues $ 71,238 (20) % $ 88,819 $ 230,505 11 % $ 206,964
Title services revenues 16,818 13 % 14,940 48,565 17 % 41,465
Insurance brokerage commissions 3,426 10 % 3,112 9,562 23 % 7,794
Total Financial Services revenues 91,482 (14) % 106,871 288,632 13 % 256,223
Expenses (42,835) — % (42,807) (122,921) 10 % (112,135)
Other income (expense), net (8) (a) — 731 (a) (50)
Income before income taxes $ 48,639 (24) % $ 64,064 $ 166,442 16 % $ 144,038
Total originations:
Loans 5,078 5 % 4,858 15,082 14 % 13,202
Principal $ 1,810,722 11 % $ 1,625,250 $ 5,186,913 21 % $ 4,274,619
(a) Percentage not meaningful
Nine Months Ended
September 30,
2021 2020
Supplemental data:
Capture rate 86.1 % 86.5 %
Average FICO score 751 751
Funded origination breakdown:
Government (FHA, VA, USDA) 20 % 21 %
Other agency 73 % 71 %
Total agency 93 % 92 %
Non-agency 7 % 8 %
Total funded originations 100 % 100 %
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Revenues
Mortgage interest rates have been at or near historically low levels through 2020 and the first nine months of 2021. In the three and nine months ended September 30, 2021, loan margins are lower than the prior year periods due to competition driven by a reduction in refinance volume within the mortgage industry, which has lowered gains from the sale of mortgages in the secondary market. Total Financial Services revenues for the three months ended September 30, 2021 decreased 14% compared with the same period in 2020 primarily as a result of lower revenue per loan due to this increased competition, partially offset by higher loan origination volume resulting from Homebuilder volume growth. Financial Services revenues for the nine months ended September 30, 2021 increased 13% compared with the same period in 2020 primarily as a result of higher loan origination volume due to Homebuilder volume growth, partially offset by lower revenue per loan.
Income before income taxes
Income before income taxes for the three months ended September 30, 2021 decreased 24% compared to the same period in 2020, primarily as a result of lower revenue per loan, partially offset by higher volume. For the nine months ended September 30, 2021, income before income taxes increased 16% compared with the same period in 2020 as the result of higher volume, partially offset by lower revenue per loan.
Income Taxes
Our effective tax rate for the three and nine months ended September 30, 2021 was 23.3% and 22.4%, respectively, compared to 14.0% and 19.6%, respectively, for the same periods in 2020. The 2020 effective tax rates are lower than the 2021 effective tax rates for the same periods primarily due to federal energy efficient home credits.
Liquidity and Capital Resources
We finance our land acquisition, development, and construction activities and financial services operations using internally-generated funds supplemented by credit arrangements with third parties and capital market financing. We routinely monitor current and expected operational requirements and financial market conditions to evaluate accessing other available financing sources, including revolving bank credit and securities offerings.
At September 30, 2021, we had unrestricted cash and equivalents of $1.6 billion, restricted cash balances of $56.3 million, and $717.7 million available under our Revolving Credit Facility. We follow a diversified investment approach for our cash and equivalents by maintaining such funds with a broad portfolio of banks within our group of relationship banks in high quality, highly liquid, short-term deposits and investments. Given the financial resources available to us, we believe that we have adequate liquidity to continue funding our operations for the foreseeable future.
Our ratio of debt to total capitalization, excluding our Financial Services debt, was 22.4% at September 30, 2021, as compared with 29.5% at December 31, 2020.
Unsecured senior notes
We had $2.0 billion and $2.7 billion of unsecured senior notes outstanding at September 30, 2021 and December 31, 2020, respectively, with no repayments due until March 2026, when $500.0 million of unsecured senior notes are scheduled to mature.
In the nine months ended September 30, 2021, we accelerated the retirement of $200.0 million and $100.0 million of our unsecured notes scheduled to mature in 2026 and 2027, respectively, through a cash tender offer. The retirement resulted in a loss of $61.5 million, which includes the write-off of debt issuance costs, unamortized discounts and premiums, and transaction fees. We also retired $426.0 million of senior notes at their scheduled maturity date.
Other notes payable
Other notes payable include non-recourse and limited recourse secured notes with third parties that totaled $71.4 million and $40.1 million at September 30, 2021 and December 31, 2020, respectively. These notes have maturities ranging up to four years, are secured by the applicable land positions to which they relate, and generally have no recourse to other assets. The stated interest rates on these notes range up to 6%.
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Revolving credit facility
We maintain a revolving credit facility (the "Revolving Credit Facility") maturing in June 2023 that has a maximum borrowing capacity of $1.0 billion and contains an uncommitted accordion feature that could increase the capacity to $1.5 billion, subject to certain conditions and availability of additional bank commitments. The Revolving Credit Facility also provides for the issuance of letters of credit that reduce the available borrowing capacity under the Revolving Credit Facility, with a sublimit of $500.0 million at September 30, 2021. The interest rate on borrowings under the Revolving Credit Facility may be based on either the London Interbank Offered Rate ("LIBOR") or a base rate plus an applicable margin, as defined therein. As a precautionary measure during the initial phase of the COVID-19 pandemic, we made the decision in March 2020 to draw $700.0 million under the Revolving Credit Facility. In June 2020, we repaid the full outstanding balance of $700.0 million. We had no borrowings outstanding at either September 30, 2021 or December 31, 2020, and $282.3 million and $249.7 million of letters of credit issued under the Revolving Credit Facility at September 30, 2021 and December 31, 2020, respectively.
The Revolving Credit Facility contains financial covenants that require us to maintain a minimum Tangible Net Worth, a minimum Interest Coverage Ratio, and a maximum Debt-to-Capitalization Ratio (as each term is defined in the Revolving Credit Facility). As of September 30, 2021, we were in compliance with all covenants. Our available and unused borrowings under the Revolving Credit Facility, net of outstanding letters of credit, amounted to $717.7 million and $750.3 million at September 30, 2021 and December 31, 2020, respectively.
Financial Services debt
Pulte Mortgage maintains a master repurchase agreement with third party lenders (as amended, the "Repurchase Agreement") that matures on July 28, 2022. The maximum aggregate commitment was $580.0 million at September 30, 2021, which will increase to $650.0 million during the seasonally high borrowing period from December 27, 2021 through January 13, 2022. At all other times, the maximum aggregate commitment ranges from $460.0 million to $550.0 million. Borrowings under the Repurchase Agreement are secured by residential mortgage loans available-for-sale. The Repurchase Agreement contains various affirmative and negative covenants applicable to Pulte Mortgage, including quantitative thresholds related to net worth, net income, and liquidity. Pulte Mortgage had $476.5 million and $411.8 million outstanding under the Repurchase Agreement at September 30, 2021 and December 31, 2020, respectively, and was in compliance with all of its covenants and requirements as of such dates.
Dividends and share repurchase program
In the nine months ended September 30, 2021, we declared cash dividends totaling $110.3 million and repurchased 12.0 million shares under our repurchase authorization for $614.3 million. On April 26, 2021, the Board of Directors approved an additional share repurchase authorization of $1.0 billion. At September 30, 2021, we had remaining authorization to repurchase $740.6 million of common shares.
Cash flows
Operating activities
Net cash provided by operating activities for the nine months ended September 30, 2021 was $548.2 million. Generally, the primary drivers of our cash flow from operations are profitability and changes in the levels of inventory and residential mortgage loans available-for-sale, each of which experiences seasonal fluctuations. The positive cash flow from operations for the nine months ended September 30, 2021 was primarily due to our net income of $1.3 billion, which included various non-cash items including a loss on debt retirement of $61.5 million, partially offset by a net increase in inventories of $1.1 billion, which was primarily attributable to higher house inventory in production resulting from higher sales activity and extended production cycle times combined with higher investment in land inventory to support future growth.
Net cash provided by operating activities for the nine months ended September 30, 2020 was $1.3 billion. The positive cash flow from operations for the nine months ended September 30, 2020 was primarily due to our net income of $968.7 million, which included various non-cash items, a seasonal $108.2 million decrease in residential mortgage loans available-for-sale, and a net decrease in inventories of $84.3 million. The decrease in inventories resulted from our deliberate efforts to reduce inventory spend, especially land acquisition and development spend, during the second quarter of 2020 in response to the COVID-19 pandemic. While a seasonal increase in house inventory partially offset the reduced land expenditures, the size of the seasonal increase was lower as we tightly managed production levels during the second quarter of 2020.
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Investing activities
Net cash used in investing activities for the nine months ended September 30, 2021 was $86.5 million. These cash outflows primarily reflected a $10.4 million deferred payment related to the acquisition of Innovative Construction Group ("ICG"), $35.8 million of investments in unconsolidated entities, as well as capital expenditures of $52.1 million related to our ongoing investments in new communities and certain information technology applications. These outflows were partially offset by distributions from unconsolidated entities of $11.5 million.
Net cash used in investing activities for the nine months ended September 30, 2020 was $107.2 million. These cash outflows primarily reflected our acquisition of ICG in January 2020 for $83.3 million, as well as capital expenditures of $46.9 million related to our ongoing investments in new communities and certain information technology applications. These outflows were partially offset by distributions from unconsolidated entities of $19.9 million.
Financing activities
Net cash used in financing activities for the nine months ended September 30, 2021 totaled $1.5 billion. These cash outflows resulted primarily from the repurchase of 12.0 million common shares for $614.3 million under our share repurchase authorization, repayments of debt totaling $797.4 million, and payments of $111.7 million in cash dividends. These outflows were partially offset by net borrowings of $64.7 million under the Repurchase Agreement to support higher loan originations resulting from growth in home closing volume.
Net cash used in financing activities for the nine months ended September 30, 2020 totaled $296.7 million. These cash outflows resulted primarily from the repurchase of 2.8 million common shares for $95.7 million under our share repurchase authorization, repayments of debt totaling $11.0 million, payments of $97.8 million in cash dividends, and net repayments of $77.5 million for borrowings under the Repurchase Agreement.
Inflation
We, and the homebuilding industry in general, may be adversely affected during periods of inflation because of higher land and construction costs. Inflation may also increase our financing costs. In addition, higher mortgage interest rates affect the affordability of our products to prospective homebuyers. While we attempt to pass on increases in our costs through increased sales prices, market forces may limit our ability to do so. If we are unable to raise sales prices enough to compensate for higher costs, or if mortgage interest rates increase significantly, our revenues, gross margins, and net income could be adversely affected.
Seasonality
Although significant changes in market conditions have impacted our seasonal patterns in the past and could do so again, we historically experience variability in our quarterly results from operations due to the seasonal nature of the homebuilding industry. We generally experience increases in revenues and cash flow from operations in the fourth quarter based on the timing of home closings. This seasonal activity increases our working capital requirements in our third and fourth quarters to support our home production and loan origination volumes. As a result of the seasonality of our operations, our quarterly results of operations are not necessarily indicative of the results that may be expected for the full year. Additionally, given the disruption in economic activity caused by the COVID-19 pandemic, our quarterly results for 2021 and 2020 are not necessarily indicative of results that may be achieved in the future.
Contractual Obligations and Commercial Commitments
There have been no material changes to our contractual obligations from those disclosed in our "Contractual Obligations and Commercial Commitments" contained in Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operation s, included in our Annual Report on Form 10-K for the year ended December 31, 2020, with the exception of the retirement of $426 million, $200 million, and $100 million of unsecured senior notes previously scheduled to mature in March 2021, March 2026, and January 2027, respectively.
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Supplemental Guarantor Financial Information
As of September 30, 2021, PulteGroup, Inc. had outstanding $2.0 billion principal amount of unsecured senior notes due at dates from March 2026 through February 2035 and no amounts outstanding on its Revolving Credit Facility.
All of our unsecured senior notes and the Revolving Credit Facility are fully and unconditionally guaranteed, on a joint and several basis, by certain subsidiaries of PulteGroup, Inc. ("Guarantors" or "Guarantor Subsidiaries"). Each of the Guarantor Subsidiaries is 100% owned, directly or indirectly, by PulteGroup, Inc. Our subsidiaries associated with our financial services operations and certain other subsidiaries do not guarantee the unsecured senior notes or the Revolving Credit Facility (collectively, "Non-Guarantor Subsidiaries"). The guarantees are senior unsecured obligations of each Guarantor and rank equal with all existing and future senior debt of such Guarantor and senior to all subordinated debt of such Guarantor. The guarantees are effectively subordinated to any secured debt of such Guarantor to the extent of the value of the assets securing such debt.
A court could void or subordinate any Guarantor’s guarantee under the fraudulent conveyance laws if existing or future creditors of any such Guarantor were successful in establishing that such Guarantor:
(a) incurred the guarantee with the intent of hindering, delaying or defrauding creditors; or
(b) received less than reasonably equivalent value or fair consideration in return for incurring the guarantee and, in the case of any one of the following is also true at the time thereof:
• such Guarantor was insolvent or rendered insolvent by reason of the issuance of the incurrence of the guarantee;
• the incurrence of the guarantee left such Guarantor with an unreasonably small amount of capital or assets to carry on its business;
• such Guarantor intended to, or believed that it would, incur debts beyond its ability to pay as they mature;
• such Guarantor was a defendant in an action for money damages, or had a judgment for money damages docketed against it, if the judgment is unsatisfied after final judgment.
The measures of insolvency for purposes of determining whether a fraudulent conveyance occurred would vary depending upon the laws of the relevant jurisdiction and upon the valuation assumptions and methodology applied by the court. However, in general, a court would deem a company insolvent if:
• the sum of its debts, including contingent and unliquidated liabilities, was greater than the fair salable value of all of its assets;
• the present fair salable value of its assets was less than the amount that would be required to pay its probable liability on its existing debts, including contingent liabilities, as they become absolute and mature; or
• it could not pay its debts as they became due.
The guarantees of the senior notes contain a provision to limit each Guarantor’s liability to the maximum amount that it could incur without causing the incurrence of obligations under its guarantee to be a fraudulent transfer. However, under recent case law, this provision may not be effective to protect such guarantee from being voided under fraudulent transfer law or otherwise determined to be unenforceable. If a court were to find that the incurrence of a guarantee was a fraudulent transfer or conveyance, the court could void the payment obligations under that guarantee, could subordinate that guarantee to presently existing and future indebtedness of the Guarantor or could require the holders of the senior notes to repay any amounts received with respect to that guarantee. In the event of a finding that a fraudulent transfer or conveyance occurred, you may not receive any repayment on the senior notes.
Finally, as a court of equity, a bankruptcy court may subordinate the claims in respect of the guarantees to other claims against us under the principle of equitable subordination if the court determines that (1) the holder of senior notes engaged in some type of inequitable conduct, (2) the inequitable conduct resulted in injury to our other creditors or conferred an unfair advantage upon the holders of senior notes and (3) equitable subordination is not inconsistent with the provisions of the bankruptcy code.
On the basis of historical financial information, operating history and other factors, we believe that each of the Guarantors, after giving effect to the issuance of the guarantees when such guarantees were issued, was not insolvent, did not have unreasonably small capital for the business in which it engaged and did not and has not incurred debts beyond its ability to pay such debts as they mature. There can be no assurance, however, as to what standard a court would apply in making these determinations or that a court would agree with our conclusions in this regard.
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The following tables present summarized financial information for PulteGroup, Inc. and the Guarantor Subsidiaries on a combined basis after intercompany transactions and balances have been eliminated among PulteGroup, Inc. and the Guarantor Subsidiaries, as well as their investment in and equity in earnings from the Non-Guarantor Subsidiaries ($000’s omitted):
PulteGroup, Inc. and Guarantor Subsidiaries
Summarized Balance Sheet Data
ASSETS September 30, 2021 December 31, 2020
Cash, cash equivalents, and restricted cash $1,539,275 $2,429,639
House and land inventory 8,748,663 7,600,542
Total assets 11,369,170 11,028,911
LIABILITIES
Accounts payable, customer deposits,
accrued and other liabilities $2,528,501 $2,101,427
Notes payable 2,059,923 2,752,302
Amount due to Non-Guarantor Subsidiaries 55,142 12,208
Total liabilities 4,713,444 4,948,275
Nine Months Ended
September 30,
Summarized Statement of Operations Data 2021 2020
Revenues $9,035,505 $7,424,736
Cost of revenues 6,664,370 5,631,840
Selling, general, and administrative expenses 852,397 713,360
Income before income taxes 1,427,182 1,040,803
Off-Balance Sheet Arrangements
We use letters of credit and surety bonds to guarantee our performance under various contracts, principally in connection with the development of our homebuilding projects. The expiration dates of the letter of credit contracts coincide with the expected completion date of the related homebuilding projects. If the obligations related to a project are ongoing, annual extensions of the letters of credit are typically granted on a year-to-year basis. At September 30, 2021, we had outstanding letters of credit totaling $282.3 million. Our surety bonds generally do not have stated expiration dates; rather, we are released from the bonds as the contractual performance is completed. These bonds, which approximated $1.8 billion at September 30, 2021, are typically outstanding over a period of approximately three to five years. Because significant construction and development work has been performed related to projects that have not yet received final acceptance by the respective counterparties, the aggregate amount of surety bonds outstanding is in excess of the projected cost of the remaining work to be performed.
In the ordinary course of business, we enter into land option agreements in order to procure land for the construction of houses in the future. At September 30, 2021, these agreements had an aggregate remaining purchase price of $5.3 billion. Pursuant to these land option agreements, we generally provide a deposit to the seller as consideration for the right to purchase land at different times in the future, usually at predetermined prices.
Critical Accounting Policies and Estimates
There have been no significant changes to our critical accounting policies and estimates in the nine months ended September 30, 2021 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, 2020.
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Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.