The following discussion and analysis should be read in conjunction with the section "Selected Financial Data" and our consolidated financial statements and the related notes included elsewhere in this Form 10-K. Results of Operations Selected Financial Information Year Ended December 31, 2013 2012 2011 (Dollars in thousands, except per share amounts) Homebuilding: Home sale revenues
$ 1,898,989 $ 1,190,252 $ 882,094Land sale revenues 15,620 46,706 899 Total revenues 1,914,609 1,236,958 882,993 Cost of home sales (1,431,797 ) (946,630 ) (719,893 ) Cost of land sales (13,616 ) (46,654 ) (903 ) Total cost of sales (1,445,413 ) (993,284 ) (720,796 ) Gross margin 469,196 243,674 162,197 Gross margin percentage 24.5 % 19.7 % 18.4 % Selling, general and administrative expenses (230,691 ) (172,207 ) (154,375 ) Income (loss) from unconsolidated joint ventures 949 (2,090 ) 207 Interest expense - (6,396 ) (25,168 ) Other income (expense) 6,815 4,664 (1,017 ) Homebuilding pretax income (loss) 246,269 67,645 (18,156 ) Financial Services: Revenues 24,910 21,300 10,907 Expenses (14,159 ) (11,062 ) (9,401 ) Other income 678 304 177 Financial services pretax income 11,429 10,542 1,683 Income (loss) before income taxes 257,698 78,187 (16,473 ) (Provision) benefit for income taxes (68,983 ) 453,234 56 Net income (loss) 188,715 531,421 (16,417 ) Less: Net (income) loss allocated to preferred shareholder (57,386 ) (224,408 ) 7,101 Less: Net (income) loss allocated to unvested restricted stock (265 ) (410 ) -
Net income (loss) available to common stockholders $ 131,064
Income (Loss) per common share: Basic $ 0.52 $ 1.52
$ (0.05 )Diluted $ 0.47 $ 1.44 $ (0.05 )Weighted average common shares outstanding: Basic 253,118,247 201,953,799 193,909,714 Diluted 291,173,953 220,518,897 193,909,714 Weighted average additional common shares outstanding if preferred shares converted to common shares: 110,826,557
Total weighted average diluted common shares outstanding if preferred shares converted to common shares: 402,000,510
Net cash provided by (used in) operating activities
$ (154,216 ) $ (283,116 ) $ (322,613 )Net cash provided by (used in) investing activities $ (143,857 ) $ (105,205 ) $ (8,313 )Net cash provided by (used in) financing activities $ 314,809 $ 324,354 $ 10,077Adjusted Homebuilding EBITDA (1) $ 383,621 $ 193,903 $ 105,855(1) Adjusted Homebuilding EBITDA means net income (loss) (plus cash distributions of income from unconsolidated joint ventures) before (a)
income taxes, (b) homebuilding interest expense, (c) expensing of previously
capitalized interest included in cost of sales, (d) impairment charges and deposit write-offs, (e) gain (loss) on early extinguishment of debt, (f)
homebuilding depreciation and amortization, (g) amortization of stock-based
compensation, (h) income (loss) from unconsolidated joint ventures and (i) income (loss) from financial services subsidiary. Other companies may calculate Adjusted Homebuilding EBITDA (or similarly titled measures)
differently. We believe Adjusted Homebuilding EBITDA information is useful
to management and investors as one measure of our ability to service debt
and obtain financing. However, it should be noted that Adjusted Homebuilding
EBITDA is not a U.S. generally accepted accounting principles ("GAAP")
financial measure. Due to the significance of the GAAP components excluded,
Adjusted Homebuilding EBITDA should not be considered in isolation or as an
alternative to cash flows from operations or any other liquidity performance
measure prescribed by GAAP. 18
Table of Contents Selected Financial Information (continued) (1) Continued The table set forth below reconciles net cash provided by (used in) operating activities, calculated and presented in accordance with GAAP, to Adjusted Homebuilding EBITDA. Year Ended December 31, 2013 2012 2011 (Dollars in thousands) Net cash provided by (used in) operating activities
$ (154,216 ) $ (283,116 ) $ (322,613 )Add: Provision (benefit) for income taxes 68,983 (453,234 ) (56 ) Deferred income tax benefit (provision) (84,214 ) 454,000 - Homebuilding interest amortized to cost of sales and interest expense 121,778 110,298 94,804 Less: Income from financial services subsidiary 10,751 10,238 1,506 Depreciation and amortization from financial services subsidiary 121 108 611 Loss on disposal of property and equipment 17 37 179 Net changes in operating assets and liabilities: Trade and other receivables 3,244 (801 ) 5,358 Mortgage loans held for sale 2,543 46,339 43,661 Inventories-owned 415,312 315,639 282,447 Inventories-not owned 43,319 31,551 19,727 Other assets (965 ) (2,618 ) (6,212 ) Accounts payable (13,325 ) (4,617 ) (1,113 ) Accrued liabilities (7,949 ) (9,155 ) (7,852 ) Adjusted Homebuilding EBITDA $ 383,621 $ 193,903 $ 105,855Overview We are focused on acquiring and developing strategically located and appropriately priced land and on designing and building highly desirable, amenity-rich communities and homes that appeal to the move-up and luxury home buying segments we target. The execution of this move-up strategy, coupled with the lift we experienced from improved market conditions, drove the strong financial performance we achieved in 2013, the fourth most profitable year in the Company's nearly 50-year history. We reported net income of $188.7 million, or $0.47per diluted share, for 2013 (2013 net income included the aggregate income tax benefit of $30.6 millionrelated primarily to the partial reversal of our deferred tax asset valuation allowance and the reversal of our liability for unrecognized tax benefits during the year), compared to net income of $531.4 million, or $1.44per diluted share for 2012 (2012 net income included the $454 milliontax benefit we received in 2012 from the reversal of a significant portion of our deferred tax asset valuation allowance), and a net loss of $16.4 million, or $0.05per share, for 2011. Homebuilding pretax income for 2013 was $246.3 million, compared to $67.6 millionin 2012 and a loss of $18.2 millionin 2011. 2013 homebuilding revenues, new home deliveries, net new orders and homes in backlog were up 55%, 40%, 22% and 21%, respectively, as compared to 2012, and our average selling price of homes delivered was $413 thousand, a 14% increase from the prior year. Our gross margin from home sales rose to 24.6% for 2013, a 410 basis point increase compared to 2012 and our operating margin from home sales for 2013 was 12.5%, a 650 basis point increase compared to 2012. We ended 2013 with $376.9 millionof homebuilding cash (including $21.5 millionof restricted cash), compared to $366.8 million(including $26.9 millionof restricted cash) at the end of the prior year. Net cash used in operating activities during 2013 was $154.2 millioncompared to $283.1 millionin 2012. The lower level of cash used in operating activities for 2013 as compared to the prior year was driven primarily by a 55% increase in homebuilding revenues, partially offset by a $77.4 millionincrease in cash land purchase and development costs. Cash flows from financing activities for 2013 included $296 millionof net proceeds from a senior notes offering during the 2013 third quarter. In October 2013, we amended our revolving credit facility to, among other things, increase the total aggregate commitment to $470 million. Tranche B of the revolver matures on February 28, 2014, at which time the total aggregate commitment and the accordion feature will be reduced to $440 millionand $520 million, respectively. 19
Table of Contents Homebuilding Year Ended December 31, 2013 2012 2011 (Dollars in thousands) Homebuilding revenues: California
$ 1,006,572 $ 699,672 $ 506,002Southwest 411,967 248,421 190,622 Southeast 496,070 288,865 186,369 Total homebuilding revenues $ 1,914,609 $ 1,236,958 $ 882,993Homebuilding pretax income (loss): California $ 164,805 $ 46,491 $ 6,310Southwest 42,792 12,852 (12,345 ) Southeast 38,672 8,302 (12,121 ) Total homebuilding pretax income (loss) $ 246,269$
Homebuilding inventory impairment charges (1): California $ - $ -
$ 9,490Southwest - - 2,878 Southeast - - 821
Total homebuilding inventory impairment charges $ - $
$ 13,189As of December 31, 2013 2012 2011 (Dollars in thousands) Total Assets: California $ 1,344,605 $ 1,192,249 $ 985,560Southwest 641,711 496,902 355,060 Southeast 785,988 438,122 294,996 Corporate 740,950 842,705 473,971 Total homebuilding 3,513,254 2,969,978 2,109,587 Financial services 148,851 143,096 90,796 Total Assets $ 3,662,105 $ 3,113,074 $ 2,200,383
(1) Inventory impairment charges are included in cost of sales in the
accompanying consolidated statements of operations.
For 2013, we generated homebuilding pretax income of
$246.3 millioncompared to $67.6 millionin 2012. This improvement was primarily the result of a 40% increase in new home deliveries, an increase in gross margin from home sales, a $6.4 milliondecrease in interest expense and the operating leverage inherent in our business. For 2012, we generated homebuilding pretax income of $67.6 millioncompared to a pretax loss of $18.2 millionin 2011. This improvement was primarily the result of a 30% increase in new home deliveries, a $13.2 milliondecrease in asset impairment charges, an increase in gross margin from home sales, an $18.8 milliondecrease in interest expense and our operating leverage.
Homebuilding revenues for 2013 increased 55% from 2012 as a result of a 40% increase in new home deliveries and a 14% increase in our consolidated average home price to
$413 thousand, partially offset by a $31.1 milliondecrease in land sale revenues. Homebuilding revenues for 2012 increased 40% from 2011 as a result of a 30% increase in new home deliveries, a $45.8 millionincrease in land sale revenues and a 4% increase in our consolidated average home price to $362 thousand. 20
Table of Contents Year Ended December 31, 2013 % Change 2012 % Change 2011 New homes delivered: California 1,762 35% 1,304 34% 975 Arizona 258 4% 247 46% 169 Texas 669 42% 472 12% 420 Colorado 168 47% 114 18% 97 Nevada - (100%) 9 (40%) 15 Total Southwest 1,095 30% 842 20% 701 Florida 1,027 77% 581 30% 446 Carolinas 718 27% 564 39% 406 Total Southeast 1,745 52% 1,145 34% 852 Total 4,602 40% 3,291 30% 2,528 New home deliveries increased 40% in 2013 as compared to the prior year, driven largely by a 106% increase in the number of homes in backlog at the beginning of the year as compared to the year earlier period and a 22% increase in net new orders, partially offset by a decrease in speculative homes sold and closed during the year. New home deliveries increased 30% in 2012 compared to 2011, driven largely by a 64% increase in the number of homes in backlog at the beginning of the year as compared to the year earlier period and a 44% increase in net new orders. Year Ended December 31, 2013 % Change 2012 % Change 2011 (Dollars in thousands) Average selling prices of homes delivered: California
$ 56512% $ 506(3%) $ 519Arizona 280 31% 213 5% 202 Texas 393 24% 318 9% 292 Colorado 450 16% 388 26% 308 Nevada - - 192 1% 190 Total Southwest 375 27% 295 9% 271 Florida 279 13% 247 19% 208 Carolinas 289 17% 247 7% 231 Total Southeast 283 15% 247 13% 219 Total $ 41314% $ 3624% $ 349During 2013, our consolidated average home price increased 14% to $413 thousandas compared to $362 thousandfor 2012. This increase was largely due to higher average home prices within the majority of our markets and a decrease in the use of sales incentives. During 2012, our consolidated average home price increased 4% to $362 thousandas compared to $349 thousandfor 2011. This increase was largely due to higher average home prices within most of our markets, partially offset by lower average home prices in Californiacompared to 2011.
Our 2013 gross margin percentage from home sales was 24.6%, up 410 basis points from 20.5% in 2012. This 410 basis point increase resulted primarily from price increases, a higher proportion of deliveries from our profitable new communities, and improved margins from speculative homes sold and delivered during the year. Our 2012 gross margin percentage from home sales was 20.5%, up 210 basis points from 18.4% in 2011. This 210 basis point increase resulted primarily from a mix shift to more deliveries from higher margin communities, a decrease in the use of sales incentives, base house price increases at some of our faster selling communities, and the absence of inventory impairments in 2012.
Our 2013 SG&A expenses (including corporate G&A) were
$230.7 millioncompared to $172.2 millionfor the prior year. Despite this increase in dollar amount, our 2013 SG&A rate from home sales was 12.1% versus 14.5% for 2012. This 240 basis point improvement was primarily the result of a 60% increase in home sale revenues and our operating leverage. Our 2012 SG&A expenses (including corporate G&A) were $172.2 millioncompared to $154.4 millionfor 2011. Our 2012 SG&A rate from home sales was 14.5% versus 17.5% for 2011. This 300 basis point improvement was primarily the result of a 35% increase in home sale revenues and our operating leverage. 21
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During the year ended
December 31, 2013, our qualified assets exceeded our debt, and as of December 31, 2013, the amount of our qualified assets in excess of our debt was $430.6 million. As a result, all of our interest incurred during 2013 was capitalized in accordance with ASC Topic 835, Interest. During 2012 and 2011, the amount of our debt was in excess of our qualified assets. As a result, we expensed $6.4 millionand $25.2 millionof interest costs in 2012 and 2011, respectively. If our debt exceeds our qualified assets in the future, we will be required to expense a portion of the interest related to such debt.
Other Income (Expense)
Other income (expense) for 2013 was primarily attributable to the receipt of property insurance claim settlements of approximately
$10.2 millionand interest income of $0.8 million, partially offset by $1.7 millionof project abandonment costs and $1.2 millionof acquisition-related costs. Other income (expense) for 2012 was primarily attributable to $4.1 millionreceived in connection with a property insurance claim settlement and $1.1 millionof interest income. Operating Data Year Ended December 31, % Absorption % Absorption 2013 % Change Change (1) 2012 % Change Change (1) 2011 Net new orders (2): California 1,718 9% 14% 1,570 52% 52% 1,030 Arizona 286 7% (17%) 267 41% 81% 190 Texas 755 43% (3%) 527 12% 12% 470 Colorado 201 29% 13% 156 56% 11% 100 Nevada - (100%) - 6 (40%) - 10 Total Southwest 1,242 30% (5%) 956 24% 28% 770 Florida 1,165 48% 34% 785 45% 49% 541 Carolinas 773 10% 24% 703 55% 33% 454 Total Southeast 1,938 30% 30% 1,488 50% 41% 995 Total 4,898 22% 14% 4,014 44% 41% 2,795 (1) Represents the percentage change of net new orders per average number of selling communities during the period.
(2) Net new orders are new orders for the purchase of homes during the period,
less cancellations during such period of existing contracts for the purchase of homes. Year Ended December 31, 2013 % Change 2012 % Change 2011 Average number of selling communities during the year: California 47 (4%) 49 - 49 Arizona 9 29% 7 (22%) 9 Texas 31 48% 21 - 21 Colorado 8 14% 7 40% 5 Nevada - - - (100%) 1 Total Southwest 48 37% 35 (3%) 36 Florida 40 11% 36 (3%) 37 Carolinas 31 (11%) 35 17% 30 Total Southeast 71 - 71 6% 67 Total 166 7% 155 2% 152 Net new orders for 2013 increased 22% from the prior year on a 7% increase in the number of average active selling communities. Our monthly sales absorption rate was 2.5 per community for 2013, up from 2.2 for 2012. During the 2013 fourth quarter our monthly sales absorption rate was 1.7 per community, compared to 2.2 in both the 2012 fourth quarter and the 2013 third quarter. The 23% decrease in sales absorption rate from the 2013 third to fourth quarter is slightly higher than the seasonality we typically experience in our business, and the decrease in sales absorption rate from the 2012 fourth quarter reflected the more tempered selling conditions we experienced during the 2013 fourth quarter as well as our continued emphasis on margin over sales pace. Our consolidated cancellation rate for 2013 was 15% compared to 13% for 2012, and was 21% for the 2013 fourth quarter compared to 15% for the 2012 fourth quarter. Our 2013 fourth quarter cancellation rate was consistent with our average historical cancellation rate over the last 10 years. 22
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Net new orders for 2012 increased 44% from 2011 on a 2% increase in the number of average active selling communities. Our monthly sales absorption rate was 2.2 per community for 2012, up from 1.5 for 2011. Our consolidated cancellation rate for 2012 was 13% compared to 16% for 2011. As of December 31, 2013 2012 % Change Dollar Dollar Dollar Backlog ($ in thousands): Homes Value Homes Value Homes Value California 396
$ 262,097440 $ 218,115(10%) 20% Arizona 105 35,846 77 19,178 36% 87% Texas 290 134,583 204 78,468 42% 72% Colorado 108 54,946 75 32,230 44% 70% Total Southwest 503 225,375 356 129,876 41% 74% Florida 504 215,312 366 95,264 38% 126% Carolinas 297 97,710 242 72,214 23% 35% Total Southeast 801 313,022 608 167,478 32% 87% Total 1,700 $ 800,4941,404 $ 515,46921% 55% The dollar value of our backlog as of December 31, 2013increased 55% from 2012 to $800.5 million. The increase in backlog value from 2012 reflects the increase in order activity experienced during 2013 and a 28% increase in our consolidated average home price in backlog to $471 thousand. The higher average home price in our backlog as of December 31, 2013compared to the prior year reflected price increases within the majority of our markets, resulting from the continued execution of our move-up homebuyer focused strategy and pricing opportunities in select markets. At December 31, 2013 % Change 2012 % Change 2011 Homesites owned and controlled: California 9,638 (6%) 10,288 11% 9,230 Arizona 2,351 20% 1,965 5% 1,872 Texas 4,607 (10%) 5,129 21% 4,232 Colorado 1,307 65% 792 15% 690 Nevada 1,124 - 1,124 (1%) 1,133 Total Southwest 9,389 4% 9,010 14% 7,927 Florida 11,461 40% 8,159 29% 6,323 Carolinas 4,687 42% 3,310 12% 2,964 Total Southeast 16,148 41% 11,469 23% 9,287
Total (including joint ventures) 35,175 14% 30,767 16% 26,444
Homesites owned 27,733 9%
25,475 27% 20,035
Homesites optioned or subject to contract 7,047 51% 4,681 (10%) 5,183
Joint venture homesites (1) 395 (35%)
611 (50%) 1,226
Total (including joint ventures) (1) 35,175 14% 30,767 16% 26,444
(1) Joint venture homesites represent our expected share of land development
joint venture homesites and all of the homesites of our homebuilding joint
ventures. Total homesites owned and controlled as of
December 31, 2013increased 14% from 2012. We purchased $493.6 millionof land (6,911 homesites) during 2013, of which 37% (based on homesites) was located in Florida, 23% in the Carolinas, 19% in Californiaand 12% in Texas, with the balance spread throughout our other markets. During 2012, we purchased $542.1 millionof land (9,344 homesites), of which 39% (based on homesites) was located in California, 25% in Florida, 18% in the Carolinas and 12% in Texas, with the balance spread throughout the Company's other operations. As of December 31, 2013, we owned or controlled 35,175 homesites, of which 22,790 are owned and actively selling or under development, 7,442 are controlled or under option, and the remaining 4,943 homesites are held for future development or for sale. 23
Table of Contents At December 31, 2013 % Change 2012 % Change 2011 Homes under construction and speculative homes: Homes under construction (excluding specs) 1,130 17% 963 147% 390 Speculative homes under construction 871 43% 611 11% 550 Total homes under construction 2,001 27%
1,574 67% 940
Completed and unsold homes (excluding models) 327 52%
215 (44%) 383
Total homes under construction (excluding specs) as of
December 31, 2013increased 17% compared to December 31, 2012, primarily the result of the 21% increase in homes in backlog. During 2013, we strategically increased our speculative homes under construction. As a result of this strategy, in addition to a lower percentage of beginning completed and unsold homes sold and closed during the 2013 fourth quarter compared to the prior year period, the number of completed unsold homes as of December 31, 2013increased 52% from the year earlier period.
For 2013, our financial services subsidiary generated pretax income of
$10.8 millioncompared to $10.2 millionin 2012. The increase in 2013 was driven by a 45% increase in the dollar volume of loans closed and sold and a decrease in loan loss expense related to indemnification and repurchase allowances, from approximately $1.0 millionfor 2012 to $0for 2013. These changes were partially offset by lower margins on loan closed and sold, a $0.5 millionincrease in loan loss expense (net of recoveries) related to allowances for loans held for investment, and an increase in personnel expenses as a result of higher production levels in 2013. For 2012, our financial services subsidiary generated pretax income of $10.2 millioncompared to $1.5 millionin 2011. The increase in 2012 was driven by a 44% increase in the dollar volume of loans closed and sold, a decrease in loan loss expense related to indemnification and repurchase allowances, from approximately $4.3 millionfor 2011 to $1.0 millionfor 2012, and a $0.9 milliondecrease in loan loss expense (net of recoveries) related to allowances for loans held for investment. These changes were partially offset by an increase in personnel expenses as a result of higher production levels in 2012. 24
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The following table details information regarding loan originations and related credit statistics for our mortgage financing operations:
Year Ended December 31, 2013 2012 2011 (Dollars in thousands) Total Originations: Loans 2,982 2,352 1,759 Principal
$933,649 $662,400 $464,665Capture rate 81% 82% 78% Loans Sold to Third Parties: Loans 2,994 2,234 1,600 Principal $925,449 $616,599 $420,550
Mortgage Loan Origination Product Mix:
FHA loans 18% 23% 29% Other government loans (VA & USDA) 14% 18% 19% Total government loans 32% 41% 48% Conforming loans 65% 59% 52% Jumbo loans 3% - - 100% 100% 100% Loan Type: Fixed 96% 98% 95% ARM 4% 2% 5% Credit Quality: Avg. FICO score 744 744 743 Other Data: Avg. combined LTV ratio 84% 86% 86% Full documentation loans 100% 100% 100% Non-Full documentation loans - - -
Our 2013 provision for income taxes was
$69.0 million, which represented income tax expense of $99.6 millionrelated to our $257.7 millionof pretax income, offset by the aggregate income tax benefit of $30.6 millionwe recognized during the year (comprised primarily of $12.2 millionrelated to the reversal of our deferred tax asset valuation allowance attributable to the expiration of Internal Revenue Code Section 382 limitations, $16.1 millionrelated to the reversal of our liability for unrecognized tax benefits due to the expiration of the applicable statute of limitations and $1.0 millionrelated to the reversal of our deferred tax asset valuation allowance attributable to state net operating loss carryforwards). As of December 31, 2013, we had a $380.0 milliondeferred tax asset which was offset by a valuation allowance of $4.6 millionrelated to state net operating loss carryforwards that are limited by shorter carryforward periods. As of such date, $125.5 millionof our deferred tax asset related to net operating loss carryforwards that are subject to the Section 382 gross annual limitation of $15.6 millionfor both federal and state purposes. The $254.5 millionbalance of the deferred tax asset is not subject to such limitations. As of December 31, 2012, we had a deferred tax asset of approximately $478.1 million. At that time, $248 millionof the deferred tax asset was subject to Internal Revenue Code Section 382 limitations, of which $100 millionwas subject to the unrealized built-in loss limitations (the limitation with respect to this $100 millionexpired on June 27, 2013and the full amount remains available) and $148 millionwas subject to federal and state net operating loss carryforward limitations. Each quarter we assess our deferred tax asset to determine whether all or any portion of the asset is more likely than not unrealizable in accordance with ASC Topic 740, Income Taxes ("ASC 740"). ASC 740 requires an assessment of available positive and negative evidence and, if the available positive evidence outweighs the available negative evidence, such that we are able to conclude that it is more likely than not (likelihood of more than 50%) that our deferred tax asset will be realized, we are required to reverse any corresponding deferred tax asset valuation allowance. During the 2012 fourth quarter we conducted such an analysis and, based on an evaluation of available positive and negative information and our projection of the income we expected to generate in future years, we concluded that it was more 25
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likely than not that most of our deferred tax asset would be realized. As a result, in accordance with ASC 740, we recognized a
$453.2 millionincome tax benefit that resulted from the reversal of all but $22.7 millionof our deferred tax asset valuation allowance. Of the remaining valuation allowance as of December 31, 2012, $12.2 millionrelated primarily to potential Section 382 limitations that expired during June 2013(this portion of our deferred tax asset valuation allowance was reversed as of June 30, 2013), and $10.5 millionrelated to net operating loss carryforwards in certain states that are limited by shorter carryforward periods. The positive evidence supporting the reversal of our deferred tax asset valuation allowance as of December 31, 2012included: (i) our cumulative pretax income for the three years ended December 31, 2012, (ii) five consecutive quarters of profitability through the 2012 fourth quarter, (iii) strong growth in key financial indicators when compared to the prior year (including new orders, deliveries, revenues, gross margin, backlog and gross margin in backlog), (iv) the acceleration of new home sales and prices we experienced in most of our markets throughout 2012, and (v) macroeconomic reports of falling unemployment, historically low interest rates and high affordability. The negative evidence we evaluated included: (i) our recent cumulative losses, (ii) unsettled circumstances (general economy and housing market, mortgage credit availability), (iii) Section 382 limitations, and (iv) state net operating loss limitations. We also considered our projection of future potential taxable income as compared to the $78 millionin pretax income we earned during 2012, a year that, according to the U.S. Census Bureau, represented the 4th worst year for new home sales since the bureau began keeping this record in 1963. Taking all of the foregoing information into account, our analysis revealed that, even if new home sales were to continue at the historically low pace experienced during 2012 and we were unable to achieve pre-tax income in excess of the $78 millionin pre-tax income we experienced during 2012 (which our projections indicated would not be the case-we note that we earned $257.7 millionin pre-tax income during 2013 allowing us to utilize approximately $76 millionof our deferred tax asset related to net operating loss carryforwards and our current projections indicate we will use a significant portion of the deferred tax asset over the next five years), we would still be able to fully utilize the portion of our deferred tax asset with respect to which we reversed the valuation allowance. This fact, coupled with the other positive evidence described above, in our view significantly outweighed the available negative evidence and required us to conclude, in accordance with ASC 740, that it was more likely than not that the majority of our deferred tax asset at December 31, 2012would be realized. During the 2013 fourth quarter, we recorded a $5.9 millionreduction of the valuation allowance related to state net operating loss carryforwards, $1.0 millionof which represented an income tax benefit related to state net operating loss carryforwards that we utilized during 2013, and as a result,we concluded were more likely than not realizable, and $4.9 millionof which represented a corresponding reduction of the deferred tax asset related to state net operating loss carryforwards that expired without being utilized. We continue to evaluate our deferred tax asset on a quarterly basis and note that, if economic conditions were to change such that we earn less taxable income than the amounts described above required to fully utilize our deferred tax asset, a portion of the asset may expire unused. See Note 11 to our accompanying consolidated financial statements for further discussion.
Liquidity and Capital Resources
Our principal uses of cash over the last several years have been for:
· land acquisition · principal and interest payments on debt
· construction and development · cash collateralization · operating expenses
Cash requirements over the last several years have been met by:
· internally generated funds · joint venture financings · bank revolving credit and term loans · assessment district bond financings · land option contracts and seller notes · letters of credit and surety bonds · public and private sales of our equity · mortgage credit facilities · public and private note offerings · tax refunds For the year ended
December 31, 2013, we used $154.2 millionof cash in operating activities versus $283.1 millionin the year earlier period. The decrease in cash used in operating activities as compared to the prior year period was driven primarily by a 55% increase in homebuilding revenues, partially offset by a $77.4 millionincrease in cash land purchase and development costs. Cash flows used in investing activities for 2013 included the acquisition of approximately 30 current and future communities from a homebuilder in the Southeast during the 2013 second quarter. Cash flows from financing 26
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activities for 2013 included
Revolving Credit Facility. During the 2013 third quarter, we amended our unsecured revolving credit facility (the "Revolving Facility") to, among other things, eliminate the borrowing base and modify the mandatory repayment requirement. The Revolving Facility has an accordion feature under which the aggregate commitment may be increased subject to the availability of additional bank commitments and certain other conditions. On
October 24, 2013, we utilized the accordion feature to add $120 millionto the aggregate amount committed under the facility, increasing the total commitment to $470 million, of which $440 millionof the facility matures in October 2015and $30 millionmatures on February 28, 2014. Substantially all of our 100% owned homebuilding subsidiaries are guarantors of the Revolving Facility. Our covenant compliance for the Revolving Facility is set forth in the table below: Actual at Covenant December Requirements at Covenant and Other Requirements 31, 2013 December 31,
Consolidated Tangible Net Worth (1)
Net Homebuilding Debt to Adjusted
Consolidated Tangible Net Worth Ratio (2) 1.05 ? 2.50
Land Not Under Development Ratio:
Tangible Net Worth Ratio (3) 0.25 ? 1.00
Liquidity or Interest Coverage Ratio (4):
EBITDA (as defined in the Revolving Facility)
to Consolidated Interest Incurred (5) 2.81 ? 1.00 Investments in
Homebuilding Joint Venturesor Consolidated Homebuilding Non-Guarantor Entities (6) $259.3?
Actual/Permitted Borrowings under the Revolving Facility (7)
(1) The minimum covenant requirement amount is subject to increase over time based
on subsequent earnings (without deductions for losses) and proceeds from
(2) This covenant requirement decreases to 2.25 beginning with the period ending
thereafter. Net Homebuilding Debt represents Consolidated Homebuilding Debt
reduced for certain cash balances in excess of
(3) Land not under development is land that has not yet undergone physical site
improvement and has not been sold to a homebuyer or other third party.
(4) Under the liquidity and interest coverage ratio covenant, we are required to
either (i) maintain an unrestricted cash balance in excess of our consolidated
interest incurred for the previous four fiscal quarters or (ii) satisfy a
minimum interest coverage ratio.
(5) This covenant requirement increases to 1.25 beginning with the quarter ending
(6) Net investments in unconsolidated homebuilding joint ventures or consolidated
homebuilding non-guarantor entities must not exceed 35% of consolidated
tangible net worth plus
(7) As of
million. Letter of Credit Facilities. As of
December 31, 2013, we were party to three committed letter of credit facilities totaling $26 million, of which $4.0 millionwas outstanding. These facilities require cash collateralization and have maturity dates ranging from October 2014to October 2016. In addition, as of such date, we also had $16.7 millionoutstanding under an uncommitted letter of credit facility. As of December 31, 2013these facilities were secured by cash collateral deposits of $21.0 million. Upon maturity, we may renew or enter into new letter of credit facilities with the same or other financial institutions.
Senior and Convertible Senior Notes. As of
December 31, 2013 (Dollars in thousands) 6¼% Senior Notes due April 2014 $ 4,971 7% Senior Notes due August 2015 29,789 10¾% Senior Notes due September 2016 280,000 8?% Senior Notes due May 2018 575,000 8?% Senior Notes due January 2021 400,000 6¼% Senior Notes due December 2021 300,000 1¼% Convertible Senior Notes due August 2032 253,000 $ 1,842,760 27
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These notes contain various restrictive covenants. Our 10¾% Senior Notes due 2016 contain our most restrictive covenants, including a limitation on additional indebtedness and a limitation on restricted payments. Outside of the specified categories of indebtedness that are carved out of the additional indebtedness limitation (including a carve-out for up to
$1.1 billionin credit facility indebtedness), the Company must satisfy at least one of two conditions (either a maximum leverage condition or a minimum interest coverage condition) to incur additional indebtedness. The Company must also satisfy at least one of these two conditions to make restricted payments. Restricted payments include dividends and investments in and advances to our joint ventures and other unrestricted subsidiaries. Our ability to make restricted payments is also subject to a basket limitation (as defined in the indenture). As of December 31, 2013, as illustrated in the table below, we were able to incur additional indebtedness and make restricted payments because we satisfied both conditions. Actual at Covenant December Requirements at Covenant Requirements 31, 2013 December 31, 2013 Total Leverage Ratio:
Indebtedness to Consolidated Tangible Net
Worth Ratio 1.17 ?
Interest Coverage Ratio:
EBITDA (as defined in the indenture) to
Consolidated Interest Incurred 2.53 ?
August 2013, the Company issued $300 millionin aggregate principal amount of 6¼% Senior Notes due 2021, which are senior unsecured obligations of the Company and are guaranteed by the guarantors of our other senior notes on a senior unsecured basis. The proceeds were used for general corporate purposes. In July 2012, the Company issued $253 millionin aggregate principal amount of 1¼% Convertible Senior Notes due 2032 (the "Convertible Notes"). The Convertible Notes are senior unsecured obligations of the Company and are guaranteed by the guarantors of our other senior notes on a senior unsecured basis. The Convertible Notes bear interest at a rate of 1¼% per year and will mature on August 1, 2032, unless earlier converted, redeemed or repurchased. The holders may convert their Convertible Notes at any time into shares of the Company's common stock at an initial conversion rate of 123.7662 shares of common stock per $1,000principal amount of Convertible Notes (which is equal to an initial conversion price of approximately $8.08per share), subject to adjustment. The Company may not redeem the Convertible Notes prior to August 5, 2017. On or after August 5, 2017and prior to the maturity date, the Company may redeem for cash all or part of the Convertible Notes at a redemption price equal to 100% of the principal amount of the Convertible Notes being redeemed. On each of August 1, 2017, August 1, 2022and August 1, 2027, holders of the Convertible Notes may require the Company to purchase all or any portion of their Convertible Notes for cash at a price equal to 100% of the principal amount of the Convertible Notes to be repurchased. Potential Future Transactions. In the future, we may, from time to time, undertake negotiated or open market purchases of, or tender offers for, our notes prior to maturity when they can be purchased at prices that we believe are attractive. We may also, from time to time, engage in exchange transactions (including debt for equity and debt for debt transactions) for all or part of our notes. Such transactions, if any, will depend on market conditions, our liquidity requirements, contractual restrictions and other factors. Joint Venture Loans. As described more particularly under the heading "Off-Balance Sheet Arrangements", our land development and homebuilding joint ventures have historically obtained secured acquisition, development and/or construction financing. This financing is designed to reduce the use of funds from our corporate financing sources. As of December 31, 2013, only one joint venture had $30.0 millionof bank debt outstanding. This joint venture bank debt was non-recourse to us. Secured Project Debt and Other Notes Payable. At December 31, 2013, we had $6.4 millionoutstanding in secured project debt and other notes payable. Our secured project debt and other notes payable consist of seller non-recourse financing and community development district and similar assessment district bond financings used to finance land acquisition, development and infrastructure costs for which we are responsible. Mortgage Credit Facilities. At December 31, 2013, we had $100.9 millionoutstanding under our mortgage financing subsidiary's mortgage credit facilities. These mortgage credit facilities consist of a $125 millionrepurchase facility with one lender, maturing in May 2014, and a $75 millionrepurchase facility with another lender, maturing in September 2014. These facilities require Standard Pacific Mortgageto maintain cash collateral accounts, which totaled $1.3 millionas of December 31, 2013, and also contain financial covenants which require Standard Pacific Mortgageto, among other things, maintain a 28
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minimum level of tangible net worth, not to exceed a debt to tangible net worth ratio, maintain a minimum liquidity amount based on a measure of total assets (inclusive of the cash collateral requirement), and satisfy pretax income (loss) requirements. As of
December 31, 2013, Standard Pacific Mortgagewas in compliance with the financial and other covenants contained in these facilities. Surety Bonds. Surety bonds serve as a source of liquidity for the Company because they are used in lieu of cash deposits and letters of credit that would otherwise be required by governmental entities and other third parties to ensure our completion of the infrastructure of our projects and other performance. At December 31, 2013, we had approximately $448.0 millionin surety bonds outstanding (exclusive of surety bonds related to our joint ventures), with respect to which we had an estimated $274.7 millionremaining in cost to complete. Availability of Additional Liquidity. The availability of additional capital, whether from private capital sources (including banks) or the public capital markets, fluctuates as market conditions change. There may be times when the private capital markets and the public debt or equity markets lack sufficient liquidity or when our securities cannot be sold at attractive prices, in which case we would not be able to access capital from these sources. A weakening of our financial condition, including in particular, a material increase in our leverage or a decrease in our profitability or cash flows, could adversely affect our ability to obtain necessary funds, result in a credit rating downgrade or change in outlook, or otherwise increase our cost of borrowing.
Dividends & Stock Repurchases. We did not pay dividends or repurchase capital stock during the years ended
Leverage. Our homebuilding debt to total book capitalization as of
December 31, 2013was 55.6% and our adjusted net homebuilding debt to adjusted total book capitalization was 49.9%. In addition as of December 31, 2013and 2012, our homebuilding debt to adjusted homebuilding EBITDA was 4.8x and 8.0x, respectively, and our adjusted net homebuilding debt to adjusted homebuilding EBITDA was 3.8x and 6.1x, respectively. We believe that these adjusted ratios are useful to investors as additional measures of our ability to service debt.
The following table summarizes our future estimated cash payments under existing contractual obligations as of
December 31, 2013, including estimated cash payments due by period. Payments Due by Period Less Than After Total 1 Year 1-3 Years 4-5 Years 5 Years (Dollars in thousands) Contractual Obligations Long-term debt principal payments (1) $ 1,849,111 $ 8,631 $ 311,591 $ 575,889 $ 953,000Long-term debt interest payments 746,691 136,228 260,192 177,124 173,147 Operating leases (2) 11,263 3,479 5,482 2,302 - Purchase obligations (3) 406,301 253,367 100,540 52,394 - Total $ 3,013,366 $ 401,705 $ 677,805 $ 807,709 $ 1,126,147
(1) Long-term debt represents senior and convertible senior notes payable and
secured project debt and other notes payable. For a more detailed description
of our long-term debt, please see Note 6 in our accompanying consolidated
(2) For a more detailed description of our operating leases, please see Note 10.f.
in our accompanying consolidated financial statements.
(3) Purchase obligations represent commitments (net of deposits) for land purchase
and option contracts with non-refundable deposits. For a more detailed
description of our land purchase and option contracts, please see "Off-Balance
Sheet Arrangements" below and Note 10.a. in our accompanying consolidated
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Off-Balance Sheet Arrangements
We are subject to customary obligations associated with entering into contracts for the purchase of land and improved homesites. These purchase contracts typically require us to provide a cash deposit or deliver a letter of credit in favor of the seller, and our purchase of properties under these contracts is generally contingent upon satisfaction of certain requirements by the sellers, including obtaining applicable property and development entitlements. We also utilize option contracts with land sellers as a method of acquiring land in staged takedowns, to help us manage the financial and market risk associated with land holdings, and to reduce the near-term use of funds from our corporate financing sources. Option contracts generally require us to provide a non-refundable deposit for the right to acquire lots over a specified period of time at predetermined prices. We generally have the right at our discretion to terminate our obligations under both purchase contracts and option contracts by forfeiting our cash deposit or by repaying amounts drawn under our letter of credit with no further financial responsibility to the land seller, although in certain instances, the land seller has the right to compel us to purchase a specified number of lots at predetermined prices. In some instances, we may also expend funds for due diligence, development and construction activities with respect to our land purchase and option contracts prior to purchase, which we would have to write off should we not purchase the land. At
December 31, 2013, we had non-refundable cash deposits outstanding of approximately $39.9 millionand capitalized pre-acquisition and other development and construction costs of approximately $2.9 millionrelating to land purchase and option contracts having a total remaining purchase price of approximately $406.3 million. Our utilization of option contracts is dependent on, among other things, the availability of land sellers willing to enter into option takedown arrangements, the availability of capital to financial intermediaries, general housing market conditions, and geographic preferences. Options may be more difficult to procure from land sellers in strong housing markets and are more prevalent in certain geographic regions.
Historically, we have entered into land development and homebuilding joint ventures from time to time as a means of:
· accessing larger or highly · expanding our market desirable lot positions opportunities · establishing strategic · managing the financial and alliances
market risk associated with
· leveraging our capital base land holdings
These joint ventures have historically obtained secured acquisition, development and/or construction financing designed to reduce the use of funds from our corporate financing sources. As of
December 31, 2013, we held membership interests in 20 homebuilding and land development joint ventures, of which eight were active and 12 were inactive or winding down. As of such date, only one joint venture had $30 millionof project specific debt outstanding. This joint venture debt is non-recourse to us and is scheduled to mature in June 2014. As of December 31, 2013, we had $2.7 millionof joint venture surety bonds outstanding subject to indemnity arrangements by us and had an estimated $0.2 millionremaining in cost to complete.
Critical Accounting Policies
The preparation of our consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of our assets, liabilities, revenues and expenses, and the related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates and judgments, including those that impact our most critical accounting policies. We base our estimates and judgments on historical experience and various other assumptions that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. We believe that the accounting policies related to the following accounts or activities are those that are most critical to the portrayal of our financial condition and results of operations and require the more significant judgments and estimates: 30
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We operate two principal businesses: homebuilding and financial services (consisting of our mortgage financing and title operations). In accordance with ASC Topic 280, Segment Reporting ("ASC 280"), we have determined that each of our homebuilding operating divisions and our financial services operations are our operating segments. Corporate is a non-operating segment. Our homebuilding operations acquire and develop land and construct and sell single-family attached and detached homes. In accordance with the aggregation criteria defined in ASC 280, our homebuilding operating segments have been grouped into three reportable segments:
California; Southwest, consisting of our operating divisions in Arizona, Texas, Coloradoand Nevada; and Southeast, consisting of our operating divisions in Floridaand the Carolinas. In particular, we have determined that the homebuilding operating divisions within their respective reportable segments have similar economic characteristics, including similar historical and expected future long-term gross margin percentages. In addition, the operating divisions also share all other relevant aggregation characteristics prescribed in ASC 280, such as similar product types, production processes and methods of distribution. Our mortgage financing operation provides mortgage financing to many of our homebuyers in substantially all of the markets in which we operate, and sells substantially all of the loans it originates in the secondary mortgage market. Our title services operation provides title examinations for our homebuyers in Texas. Our mortgage financing and title services operations are included in our financial services reportable segment, which is separately reported in our consolidated financial statements under "Financial Services." Corporate is a non-operating segment that develops and implements strategic initiatives and supports our operating segments by centralizing key administrative functions such as accounting, finance and treasury, information technology, insurance and risk management, litigation, marketing and human resources. Corporate also provides the necessary administrative functions to support us as a publicly traded company. A substantial portion of the expenses incurred by Corporate are allocated to each of our operating divisions based on their respective percentage of revenues.
Inventories and Impairments
Inventories consist of land, land under development, homes under construction, completed homes and model homes and are stated at cost, net of any impairment losses. We capitalize direct carrying costs, including interest, property taxes and related development costs to inventories. Field construction supervision and related direct overhead are also included in the capitalized cost of inventories. Direct construction costs are specifically identified and allocated to homes while other common costs, such as land, land improvements and carrying costs, are allocated to homes within a community based upon their anticipated relative sales or fair value. We assess the recoverability of real estate inventories in accordance with the provisions of ASC Topic 360, Property, Plant, and Equipment ("ASC 360"). ASC 360 requires long-lived assets, including inventories, that are expected to be held and used in operations to be carried at the lower of cost or, if impaired, the fair value of the asset. ASC 360 requires that companies evaluate long-lived assets for impairment based on undiscounted future cash flows of the assets at the lowest level for which there is identifiable cash flows. Long-lived assets to be disposed of are reported at the lower of carrying amount or fair value less cost to sell. We evaluate real estate projects (including unconsolidated joint venture real estate projects) for inventory impairments when indicators of potential impairment are present. Indicators of impairment include, but are not limited to: significant decreases in local housing market values and selling prices of comparable homes; significant decreases in gross margins and sales absorption rates; accumulation of costs in excess of budget; actual or projected operating or cash flow losses; and current expectations that a real estate asset will more likely than not be sold before its previously estimated useful life. We perform a detailed budget and cash flow review of all of our real estate projects (including projects actively selling as well as projects under development and on hold) on a periodic basis throughout each fiscal year to, among other things, determine whether the estimated remaining undiscounted future cash flows of the project are more or less than the carrying value of the asset. If the undiscounted cash flows are more than the carrying value of the real estate project, then no impairment adjustment is required. However, if the undiscounted cash flows are less than the carrying amount, then the asset is deemed impaired and is written-down to its fair value. We evaluate the identifiable cash flows at the project level. When estimating undiscounted future cash flows of a project, we are required to make various assumptions, including the following: (i) the expected sales prices and sales incentives to be offered, including the number of homes available and pricing and incentives being offered in other communities by us or by other builders; (ii) the expected sales pace and 31
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cancellation rates based on local housing market conditions and competition; (iii) costs expended to date and expected to be incurred in the future, including, but not limited to, land and land development costs, home construction costs, interest costs, indirect construction and overhead costs, and selling and marketing costs; (iv) alternative product offerings that may be offered that could have an impact on sales pace, sales price and/or building costs; and (v) alternative uses for the property such as the possibility of a sale of lots to a third party versus the sale of individual homes. Many of these assumptions are interdependent and changing one assumption generally requires a corresponding change to one or more of the other assumptions. For example, increasing or decreasing the sales absorption rate has a direct impact on the estimated per unit sales price of a home, the level of time sensitive costs (such as indirect construction, overhead and carrying costs), and selling and marketing costs (such as model maintenance costs and promotional and advertising campaign costs). Depending on what objective we are trying to accomplish with a community, it could have a significant impact on the project cash flow analysis. For example, if our business objective is to drive delivery levels our project cash flow analysis will be different than if the business objective is to preserve operating margins. These objectives may vary significantly from project to project, from division to division, and over time with respect to the same project. Once we have determined a real estate project is impaired, we calculate the fair value of the project under a land residual value analysis and in certain cases in conjunction with a discounted cash flow analysis. Under the land residual value analysis, we estimate what a willing buyer (including us) would pay and what a willing seller would sell a parcel of land for (other than in a forced liquidation) in order to generate a market rate operating margin based on projected revenues, costs to develop land, and costs to construct and sell homes within a community. Under the discounted cash flow method, all estimated future cash inflows and outflows directly associated with the real estate project are discounted to calculate fair value. The net present value of these project cash flows are then compared to the carrying value of the asset to determine the amount of the impairment that is required. The land residual value analysis is the primary method that we use to calculate impairments as it is the principal method used by us and land sellers for determining the fair value of a residential parcel of land. In many cases, we also supplement our land residual value analysis with a discounted cash flow analysis in evaluating the fair value. In addition, for projects that require a longer time frame to develop and sell assets, in some instances we incorporate a certain level of inflation or deflation into our projected revenue and cost assumptions. This evaluation and the assumptions used by management to determine future estimated cash flows and fair value require a substantial degree of judgment, especially with respect to real estate projects that have a substantial amount of development to be completed, have not started selling or are in the early stages of sales, or are longer-term in duration. Due to the inherent uncertainty in the estimation process, significant volatility in the demand for new housing, and the availability of mortgage financing for potential homebuyers, actual results could differ significantly from our estimates. From time to time, we write-off deposits related to land options that we decide not to exercise. The decision not to exercise a land option takes into consideration changes in market conditions, the timing of required land takedowns, the willingness of land sellers to modify terms of the land option contract (including the timing of land takedowns), the availability and best use of our capital, and other factors. The write-off is charged to homebuilding other income (expense) in our consolidated statement of operations in the period that we determine it is probable that the optioned property will not be acquired. If we recover deposits which were previously written off, the recoveries are recorded to homebuilding other income (expense) in the period received. Stock-Based Compensation We account for share-based awards in accordance with ASC Topic 718, Compensation - Stock Compensation, which requires that compensation expense be measured and recognized at an amount equal to the fair value of share-based payments granted under compensation arrangements. Our outstanding share-based awards include stock options, stock appreciation rights, restricted and unrestricted stock, and performance share awards. The fair value of stock options and stock appreciation rights that vest based on time is calculated by using the Black-Scholes option-pricing model and the fair value of stock appreciation rights that vest based on market performance is calculated by using a lattice model. The fair value of restricted stock, unrestricted stock and performance share awards is based on the market value of our common stock as of the grant date. The determination of the fair value of share-based awards at the grant date requires judgment in developing assumptions and involves a number of variables. These variables include, but are not limited to: expected stock-price volatility over the term of the awards and expected stock option exercise behavior. Additionally, judgment is required in estimating the number of share-based awards that are expected to be forfeited and, in the case of performance share awards, the level of performance that will be achieved and the number of shares that will be earned. If actual results differ significantly from these estimates, stock-based compensation expense and our consolidated results of operations could be significantly impacted. 32
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Homebuilding Revenue and Cost of Sales
Homebuilding revenue and cost of sales are recognized after construction is completed, a sufficient down payment has been received, title has transferred to the homebuyer, collection of the purchase price is reasonably assured and we have no continuing involvement. Cost of sales is recorded based upon total estimated costs to be allocated to each home within a community. Any changes to the estimated costs are allocated to the remaining undelivered lots and homes within their respective community. The estimation and allocation of these costs requires a substantial degree of judgment by management. The estimation process involved in determining relative sales or fair values is inherently uncertain because it involves estimating future sales values of homes before delivery. Additionally, in determining the allocation of costs to a particular land parcel or individual home, we rely on project budgets that are based on a variety of assumptions, including assumptions about construction schedules and future costs to be incurred. It is common that actual results differ from budgeted amounts for various reasons, including construction delays, increases in costs that have not been committed or unforeseen issues encountered during construction that fall outside the scope of existing contracts, or costs that come in less than originally anticipated. While the actual results for a particular construction project are accurately reported over time, a variance between the budget and actual costs could result in the understatement or overstatement of costs and have a related impact on gross margins between reporting periods. To reduce the potential for such variances, we have procedures that have been applied on a consistent basis, including assessing and revising project budgets on a periodic basis, obtaining commitments from subcontractors and vendors for future costs to be incurred, and utilizing the most recent information available to estimate costs. We believe that these policies and procedures provide for reasonably dependable estimates for purposes of calculating amounts to be relieved from inventories and expensed to cost of sales in connection with the sale of homes.
Variable Interest Entities
We account for variable interest entities in accordance with ASC Topic 810, Consolidation ("ASC 810"). Under ASC 810, a variable interest entity ("VIE") is created when: (a) the equity investment at risk in the entity is not sufficient to permit the entity to finance its activities without additional subordinated financial support provided by other parties, including the equity holders; (b) the entity's equity holders as a group either (i) lack the direct or indirect ability to make decisions about the entity, (ii) are not obligated to absorb expected losses of the entity or (iii) do not have the right to receive expected residual returns of the entity; or (c) the entity's equity holders have voting rights that are not proportionate to their economic interests, and the activities of the entity involve or are conducted on behalf of the equity holder with disproportionately few voting rights. If an entity is deemed to be a VIE pursuant to ASC 810, the enterprise that has both (i) the power to direct the activities of a VIE that most significantly impact the entity's economic performance and (ii) the obligation to absorb the expected losses of the entity or right to receive benefits from the entity that could be potentially significant to the VIE is considered the primary beneficiary and must consolidate the VIE. In accordance with ASC 810, we perform ongoing reassessments of whether an enterprise is the primary beneficiary of a VIE.
Investments in our unconsolidated homebuilding and land development joint ventures are accounted for under the equity method of accounting. Under the equity method, we recognize our proportionate share of earnings and losses earned by the joint venture upon the delivery of lots or homes to third parties. All joint venture profits generated from land sales to us are deferred and recorded as a reduction to our cost basis in the lots we purchase until we ultimately sell the homes to be constructed to third parties. Our share of joint venture losses from land sales to us are recorded in the period we acquire the property from the joint venture. Our ownership interests in our unconsolidated joint ventures vary but are generally less than or equal to 50%. We review inventory projects within our unconsolidated joint ventures for impairments consistent with the critical accounting policy described above under "Inventories and Impairments." We also review our investments in unconsolidated joint ventures for evidence of an other than temporary decline in value. To the extent that we deem any portion of our investment in unconsolidated joint ventures not recoverable, we impair our investment accordingly. In addition, we accrue for guarantees provided to unconsolidated joint ventures when it is determined that there is an obligation that is due from us. These obligations consist of various items, including but not limited to, surety indemnities, credit enhancements provided in connection with joint venture borrowings such as loan-to-value maintenance agreements, construction completion agreements, and environmental indemnities. In many cases we share these obligations with our joint venture partners, and in some cases, we are solely responsible for such obligations. For further discussion regarding these guarantees, please see "Management's Discussion and Analysis of Financial Condition - Off-Balance Sheet Arrangements". 33
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In the normal course of business, we incur warranty-related costs associated with homes that have been delivered to homebuyers. Estimated future direct warranty costs are accrued and charged to cost of sales in the period when the related homebuilding revenues are recognized while indirect warranty overhead salaries and related costs are charged to cost of sales in the period incurred. Amounts accrued are based upon historical experience rates. We review the adequacy of the warranty accruals each reporting period by evaluating the historical warranty experience in each market in which we operate, and the warranty accruals are adjusted as appropriate for current quantitative and qualitative factors. Factors that affect the warranty accruals include the number of homes delivered, historical and anticipated rates of warranty claims, and cost per claim. Although we consider the warranty accruals reflected in our consolidated balance sheet to be adequate, actual future costs could differ significantly from our currently estimated amounts.
Insurance and Litigation Accruals
Insurance and litigation accruals are established with respect to estimated future claims cost. We maintain general liability insurance designed to protect us against a portion of our risk of loss from construction-related claims. We also generally require our subcontractors and design professionals to indemnify us for liabilities arising from their work, subject to various limitations. However, such indemnity is significantly limited with respect to certain subcontractors that are added to our general liability insurance policy. We record allowances to cover our estimated costs of self-insured retentions and deductible amounts under these policies and estimated costs for claims that may not be covered by applicable insurance or indemnities. Estimation of these accruals include consideration of our claims history, including current claims, estimates of claims incurred but not yet reported, and potential for recovery of costs from insurance and other sources. We utilize the services of an independent third party actuary to assist us with evaluating the level of our insurance and litigation accruals. Because of the high degree of judgment required in determining these estimated accrual amounts, actual future claim costs could differ significantly from our currently estimated amounts. Income Taxes We account for income taxes in accordance with ASC Topic 740, Income Taxes ("ASC 740"). This statement requires an asset and a liability approach for measuring deferred taxes based on temporary differences between the financial statement and tax bases of assets and liabilities existing at each balance sheet date using enacted tax rates for years in which taxes are expected to be paid or recovered. We evaluate our deferred tax assets on a quarterly basis to determine whether a valuation allowance is required. In accordance with ASC 740, we assess whether a valuation allowance should be established based on our determination of whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of our deferred tax assets depends primarily on our ability to generate future taxable income during the periods in which the related temporary differences become deductible. The assessment of a valuation allowance includes giving appropriate consideration to all positive and negative evidence related to the realization of the deferred tax asset. This assessment considers, among other things, the nature, frequency and severity of current and cumulative losses, forecasts of future profitability, the duration of statutory carryforward periods, our experience with operating loss and tax credit carryforwards not expiring unused, and tax planning alternatives. Significant judgment is required in determining the future tax consequences of events that have been recognized in our consolidated financial statements and/or tax returns. Differences between anticipated and actual outcomes of these future tax consequences could have a material impact on our consolidated financial position or results of operations. Changes in existing tax laws and tax rates also affect actual tax results and the valuation of deferred tax assets over time. During the 2012 fourth quarter we conducted such an analysis and, based on an evaluation of available positive and negative information and our projection of the income we expected to generate in future years, we concluded that it was more likely than not that most of our deferred tax asset would be realized. As a result, in accordance with ASC Topic 740, we recognized a
$453.2 millionincome tax benefit that resulted from the reversal of all but $22.7 millionof our deferred tax asset valuation allowance. Of the remaining valuation allowance as of December 31, 2012, $12.2 millionrelated primarily to potential Section 382 limitations that expired during June 2013(this portion of our deferred tax asset valuation allowance was reversed as of June 30, 2013), and $10.5 millionrelated to net operating loss carryforwards in certain states that are limited by shorter carryforward periods. During the 2013 fourth quarter, the Company recorded a $5.9 millionreduction of the valuation allowance related to state net operating loss carryforwards, $1.0 millionof which represented an income tax benefit related to state net operating loss carryforwards that the Company concluded were more likely than not realizable and $4.9 millionof which represented a corresponding reduction of the deferred tax asset related to state net operating loss carryforwards that expired without being utilized. 34
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December 31, 2013, the remaining valuation allowance of $4.6 millionrelates to state net operating loss carryforwards that are limited by shorter carryforward periods. To the extent that we conclude that it is more likely than not that the remaining valuation allowance will be utilized, we will be able to reduce our effective tax rate, by reducing the valuation allowance and offsetting a portion of taxable income. Conversely, any significant future operating losses generated by us in the near term may increase the deferred tax asset valuation allowance and adversely impact our income tax provision (benefit) to the extent we enter into a cumulative loss position as described in ASC 740. Interest and penalties related to unrecognized tax benefits are recognized in the financial statements as a component of income tax expense. Significant judgment is required to evaluate uncertain tax positions. We evaluate our uncertain tax positions on a quarterly basis. Our evaluations are based upon a number of factors, including changes in facts or circumstances, changes in tax law, correspondence with tax authorities during the course of audits and effective settlement of audit issues. Changes in the recognition or measurement of uncertain tax positions could result in material increases or decreases in our income tax expense in the period in which we make the change.
Recent Accounting Pronouncements
See Note 2.u. in our accompanying consolidated financial statements.
Table of Contents FORWARD-LOOKING STATEMENTS This report contains "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. In addition, other statements we may make from time to time, such as press releases, oral statements made by Company officials and other reports we file with the
Securities and Exchange Commission, may also contain such forward-looking statements. Forward-looking statements in this report include, but are not limited to, statements regarding:
· our strategy;
· our plans to continue to make substantial investments in land;
· our belief that the housing market is recovering;
· housing market conditions and trends in the geographic markets in which we
· the impact of future market rate risks on our financial assets and borrowings;
· our expectation to convert year-end backlog in 2014;
· the sufficiency of our warranty and other reserves;
· our expected equity award forfeiture rates;
· trends in new home deliveries, orders, backlog, home pricing, leverage and
· housing market conditions and trends in the geographic markets in which we
· the sufficiency of our liquidity to implement our strategy and our ability to
access additional capital and renew existing credit facilities;
· litigation outcomes and related costs;
· plans to purchase our notes prior to maturity and to engage in debt exchange
· seasonal trends relating to our operating and leverage levels;
· our ability to realize the value of our deferred tax assets and the timing
relating thereto; · our intention of not paying dividends;
· our plans to enhance revenue while maintaining an appropriate sales pace;
· our plans to concentrate operations and capital in growing markets; · amounts remaining to complete relating to existing surety bonds; and · the impact of recent accounting standards. Forward-looking statements are based on our current expectations or beliefs regarding future events or circumstances, and you should not place undue reliance on these statements. Such statements involve known and unknown risks, uncertainties, assumptions and other factors-many of which are out of our control and difficult to forecast-that may cause actual results to differ materially from those that may be described or implied. Such factors include, but are not limited to, the risks described in this Annual Report under the heading "Risk Factors," which are incorporated by reference herein. Except as required by law, we assume no, and hereby disclaim any, obligation to update any of the foregoing or any other forward-looking statements. We nonetheless reserve the right to make such updates from time to time by press release, periodic report or other method of public disclosure without the need for specific reference to this report. No such update shall be deemed to indicate that other statements not addressed by such update remain correct or create an obligation to provide any other updates.