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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the quarterly period ended March 31, 2012
[ ] Transition Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the transition period from to .
Commission File Number: 001-08029
THE RYLAND GROUP, INC.
(Exact Name of Registrant as Specified in Its Charter)
3011 Townsgate Road, Suite 200
Westlake Village, California 91361-3027
(Address and Telephone Number of Principal Executive Offices)
(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. þ Yes o No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). þ Yes o No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check one:)
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). o Yes þ No
The number of shares of common stock of The Ryland Group, Inc. outstanding on May 4, 2012, was 44,607,348.
THE RYLAND GROUP, INC.
See Notes to Consolidated Financial Statements.
See Notes to Consolidated Financial Statements.
1 Includes cash and cash equivalents of $56,000 and $39,000 associated with discontinued operations at December 31, 2011 and 2010, respectively.
2 Includes cash and cash equivalents of $57,000 and $38,000 associated with discontinued operations at March 31, 2012 and 2011, respectively.
See Notes to Consolidated Financial Statements.
CONSOLIDATED STATEMENT OF STOCKHOLDERS EQUITY
Note 1. Consolidated Financial Statements
The consolidated financial statements include the accounts of The Ryland Group, Inc. and its 100 percent-owned subsidiaries (the Company). Noncontrolling interest represents the selling entities ownership interests in land and lot option purchase contracts. (See Note 8, Variable Interest Entities (VIE).) Intercompany transactions have been eliminated in consolidation. Information is presented on a continuing operations basis unless otherwise noted. The results from continuing and discontinued operations are presented separately in the consolidated financial statements. (See Note 18, Discontinued Operations.) Effective January 1, 2012, the Company elected to reclassify its external commissions expense from cost of sales to selling, general and administrative expense in its Consolidated Statements of Earnings in order to not only be consistent with a majority of its peers, but also to combine external and internal commissions. This will have the effect of increasing both housing gross profit and selling, general and administrative expense by the amount of external commissions, which totaled $4.6 million and $3.0 million, or 2.2 percent and 1.9 percent of housing revenues, for the quarters ended March 31, 2012 and 2011, respectively. All prior period amounts have been reclassified to conform to the 2012 presentation. For a description of the Companys accounting policies, see Note A, Summary of Significant Accounting Policies, in its 2011 Annual Report on Form 10-K.
The Consolidated Balance Sheet at March 31, 2012, the Consolidated Statements of Earnings for the three-month periods ended March 31, 2012 and 2011, the Consolidated Statements of Cash Flows for the three-month periods ended March 31, 2012 and 2011, the Consolidated Statement of Stockholders Equity as of and for the period ended March 31, 2012, and the Consolidated Statements of Other Comprehensive Income for the three-month periods ended March 31, 2012 and 2011, have been prepared by the Company without audit. In the opinion of management, all adjustments, including normally recurring adjustments necessary to present fairly the Companys financial position, results of operations and cash flows at March 31, 2012, and for all periods presented, have been made. Certain information and footnote disclosures normally included in the financial statements have been condensed or omitted. These financial statements should be read in conjunction with the financial statements and related notes included in the Companys 2011 Annual Report on Form 10-K.
The Company has historically experienced, and expects to continue to experience, variability in quarterly results. Accordingly, the results of operations for the three months ended March 31, 2012, are not necessarily indicative of the operating results expected for the year ending December 31, 2012.
Note 2. Comprehensive Loss
Comprehensive loss consists of net losses and the increase or decrease in unrealized gains or losses on the Companys available-for-sale securities, as well as the decrease in unrealized gains associated with treasury locks, net of applicable taxes. Comprehensive loss totaled $4.4 million and $19.8 million for the three-month periods ended March 31, 2012 and 2011, respectively.
Note 3. Cash, Cash Equivalents and Restricted Cash
Cash and cash equivalents totaled $177.2 million and $159.4 million at March 31, 2012 and December 31, 2011, respectively. The Company considers all highly liquid short-term investments purchased with an original maturity of three months or less and cash held in escrow accounts to be cash equivalents.
At March 31, 2012 and December 31, 2011, the Company had restricted cash of $68.0 million and $56.8 million, respectively. The Company has various secured letter of credit agreements that require it to maintain cash deposits as collateral for outstanding letters of credit. Cash restricted under these agreements totaled $67.9
million and $56.7 million at March 31, 2012 and December 31, 2011, respectively. In addition, Ryland Mortgage Company and its subsidiaries and RMC Mortgage Corporation (collectively referred to as RMC) had restricted cash for funds held in trust for third parties of $70,000 and $141,000 at March 31, 2012 and December 31, 2011, respectively.
Note 4. Segment Information
The Company is a leading national homebuilder and provider of mortgage-related financial services. As one of the largest single-family on-site homebuilders in the United States, it operates in 13 states across the country. The Company consists of six segments: four geographically-determined homebuilding regions (North, Southeast, Texas and West); financial services; and corporate. The homebuilding segments specialize in the sale and construction of single-family attached and detached housing. The Companys financial services segment, which includes RMC, RH Insurance Company, Inc. (RHIC), LPS Holdings Corporation and its subsidiaries (LPS), and Columbia National Risk Retention Group, Inc. (CNRRG), provides mortgage-related products and services, as well as title, escrow and insurance services, to its homebuyers. Corporate is a nonoperating business segment with the sole purpose of supporting operations. In order to best reflect the Companys financial position and results of operations, certain corporate expenses are allocated to the homebuilding and financial services segments, along with certain assets and liabilities relating to employee benefit plans.
The Company evaluates performance and allocates resources based on a number of factors, including segment pretax earnings and risk. The accounting policies of the segments are the same as those described in Note 1, Consolidated Financial Statements.
Note 5. Earnings Per Share Reconciliation
The following table sets forth the computation of basic and diluted earnings per share:
For the three-month periods ended March 31, 2012 and 2011, the effects of outstanding restricted stock units and stock options were not included in the diluted earnings per share calculations as they would have been antidilutive due to the Companys net loss for the respective periods.
Note 6. Marketable Securities, Available-for-sale
The Companys investment portfolio includes U.S. Treasury securities; obligations of U.S. government and local government agencies; corporate debt backed by U.S. government/agency programs; corporate debt securities; asset-backed securities of U.S. government agencies and covered bonds; time deposits; and short-term pooled investments. These investments are primarily held in the custody of a single financial institution. Time deposits and short-term pooled investments, which are not considered cash equivalents, have original maturities in excess of 90 days. The Company considers its investment portfolio to be available-for-sale as defined by the Financial Accounting Standards Board (FASB) in its Accounting Standards Codification (ASC) No. 320 (ASC 320), InvestmentsDebt and Equity Securities. Accordingly, these investments are recorded at their fair values. The cost of securities sold is based on an average-cost basis. Unrealized gains and losses on these investments were included in Accumulated other comprehensive income within the Consolidated Balance Sheets.
The Company periodically reviews its available-for-sale securities for other-than-temporary declines in fair values that are below their cost bases, as well as whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. At March 31, 2012 and December 31, 2011, the Company believed that the cost bases for its available-for-sale securities were recoverable in all material respects.
For the three-month periods ended March 31, 2012 and 2011, net realized earnings associated with the Companys investment portfolio, which includes interest, dividends and net realized gains and losses on sales of marketable securities, totaled $446,000 and $1.3 million, respectively. These earnings were included in Gain from marketable securities, net within the Consolidated Statements of Earnings.
The following table sets forth the fair values of marketable securities, available-for-sale, by type of security:
The primary objectives of the Companys investment portfolio are safety of principal and liquidity. Investments are made with the purpose of achieving the highest rate of return consistent with these two objectives. The Companys investment policy limits investments to debt rated investment grade or better, as well as to bank and money market instruments and to issues by the U.S. government, U.S. government agencies and municipal or other institutions primarily with investment-grade credit ratings. Policy restrictions are placed on maturities, as well as on concentration by type and issuer.
The following table sets forth the fair values of marketable securities, available-for-sale, by contractual maturity:
Note 7. Housing Inventories
Housing inventories consist principally of homes under construction; land under development and improved lots; and inventory held-for-sale. Inventory includes land and development costs; direct construction costs; capitalized indirect construction costs; capitalized interest; and real estate taxes. The costs of acquiring and developing land and constructing certain related amenities are allocated to the parcels to which these costs relate. Interest and taxes are capitalized during active development and construction stages. Inventories to be held and used are stated at cost unless a community is determined to be impaired, in which case the impaired inventories are written down to their fair values. Inventories held-for-sale are stated at the lower of their costs or fair values, less cost to sell.
As required by ASC No. 360 (ASC 360), Property, Plant and Equipment, inventory is reviewed for potential write-downs on an ongoing basis. ASC 360 requires that, in the event that impairment indicators are present and undiscounted cash flows signify that the carrying amount of an asset is not recoverable, impairment charges must be recorded if the fair value of the asset is less than its carrying amount. The Company reviews all communities on a quarterly basis for changes in events or circumstances indicating signs of impairment. Examples of events or changes in circumstances include, but are not limited to: price declines resulting from sustained competitive pressures; a change in the manner in which the asset is being used; a change in assessments by a regulator or municipality; cost increases; the expectation that, more likely than not, an asset will be sold or disposed of significantly before the end of its previously estimated useful life; or the impact of local economic or macroeconomic conditions, such as employment or housing supply, on the market for a given product. Signs of impairment may include, but are not limited to: very low or negative profit margins; the absence of sales activity in an open community; and/or significant price differences for comparable parcels of land held-for-sale.
If it is determined that indicators of impairment exist in a community, undiscounted cash flows are prepared and analyzed at a community level based on expected pricing; sales rates; construction costs; local municipality fees; and warranty, closing, carrying, selling, overhead and other related costs; or on similar assets to determine if the realizable values of the assets held are less than their respective carrying amounts. In order to determine assumed sales prices included in cash flow models, the Company analyzes historical sales prices on homes delivered in the community and in other communities located within the geographic area, as well as sales prices included in its current backlog for such communities. In addition, it analyzes market studies and trends, which generally include statistics on sales prices in neighboring communities and sales prices of similar products in non-neighboring communities in the same geographic area. In order to estimate costs to build and deliver homes, the Company generally assumes cost structures reflecting contracts currently in place with vendors, adjusted for any anticipated cost-reduction initiatives or increases. The Companys analysis of each community generally assumes current pricing equal to current sales orders for a particular or comparable community. For a minority of communities that the Company does not intend to operate for an extended period of time or where the operating
life extends beyond several years, slight increases over current sales prices are assumed in later years. Once a community is considered to be impaired, the Companys determinations of fair value and new cost basis are primarily based on discounting estimated cash flows at rates commensurate with inherent risks that are associated with the continuing assets. Discount rates used generally vary from 19.0 percent to 30.0 percent, depending on market risk, the size or life of a community and development risk. Due to the fact that estimates and assumptions included in cash flow models are based on historical results and projected trends, unexpected changes in market conditions that may lead to additional impairment charges in the future cannot be anticipated.
Valuation adjustments are recorded against homes completed or under construction, land under development or improved lots when analyses indicate that the carrying values are greater than the fair values. Write-downs of impaired inventories to their fair values are recorded as adjustments to the cost basis of the respective inventory. At March 31, 2012 and December 31, 2011, valuation reserves related to impaired inventories amounted to $265.8 million and $277.2 million, respectively. The net carrying values of the related inventories amounted to $196.9 million and $195.8 million at March 31, 2012 and December 31, 2011, respectively.
Interest and taxes are capitalized during active development and construction stages. Capitalized interest is amortized as the related inventory is delivered to homebuyers. The following table is a summary of activity related to capitalized interest:
Additionally, at March 31, 2012, the Company controlled an aggregate of 1,329 lots associated with discontinued operations, of which 1,273 lots were owned and 56 lots were under option. At December 31, 2011, the Company controlled an aggregate of 1,386 lots associated with discontinued operations, of which 1,330 lots were owned and 56 lots were under option.
Note 8. Variable Interest Entities (VIE)
As required by ASC No. 810 (ASC 810), Consolidation of Variable Interest Entities, a VIE is to be consolidated by a company if that company has the power to direct the VIEs activities and the obligation to absorb its losses or the right to receive its benefits, which are potentially significant to the VIE. ASC 810 also requires disclosures about VIEs that the company is not obligated to consolidate, but in which it has a significant, though not primary, variable interest.
The Company enters into joint ventures, from time to time, for the purpose of acquisition and co-development of land parcels and lots. Its investment in these joint ventures may create a variable interest in a VIE, depending on the contractual terms of the arrangement. Additionally, in the ordinary course of business, the Company enters into lot option purchase contracts in order to procure land for the construction of homes. Under such lot option purchase contracts, the Company funds stated deposits in consideration for the right to purchase lots at a future point in time, usually at predetermined prices. The Companys liability is generally limited to forfeiture of nonrefundable deposits, letters of credit and other nonrefundable amounts incurred. In accordance with the requirements of ASC 810, certain of the Companys lot option purchase contracts may result in the creation of a variable interest in a VIE.
In compliance with the provisions of ASC 810, the Company consolidated $49.0 million and $51.4 million of inventory not owned related to land and lot option purchase contracts at March 31, 2012 and December 31, 2011, respectively. Although the Company may not have had legal title to the optioned land, under ASC 810, it had the primary variable interest and was required to consolidate the particular VIEs assets under option at fair value. To reflect the fair value of the inventory consolidated under ASC 810, the Company included $17.1 million and $17.2 million of its related cash deposits for lot option purchase contracts at March 31, 2012 and December 31, 2011, respectively, in Consolidated inventory not owned within the Consolidated Balance Sheets. Noncontrolling interest totaled $32.0 million and $34.2 million with respect to the consolidation of these contracts at March 31, 2012 and December 31, 2011, respectively, representing the selling entities ownership interests in these VIEs. Additionally, the Company had cash deposits and/or letters of credit totaling $21.9 million and $22.3 million at March 31, 2012 and December 31, 2011, respectively, that were associated with lot option purchase contracts having aggregate purchase prices of $203.5 million and $208.5 million, respectively. As the Company did not have the primary variable interest in these contracts, it was not required to consolidate them.
Note 9. Investments in Joint Ventures
The Company enters into joint ventures, from time to time, for the purpose of acquisition and co-development of land parcels and lots. It participates in a number of joint ventures in which it has less than a controlling interest. As of March 31, 2012, the Company participated in five active homebuilding joint ventures in the Austin, Chicago, Denver and Washington, D.C., markets. The Company recognizes its share of the respective joint ventures earnings or losses from the sale of lots to other homebuilders. It does not, however, recognize earnings from lots that it purchases from the joint ventures. Instead, the Company reduces its cost basis in each lot by its share of the earnings from the lot.
The following table summarizes each reporting segments total estimated share of lots owned and controlled by the Company under its joint ventures:
At March 31, 2012 and December 31, 2011, the Companys investments in its unconsolidated joint ventures totaled $9.5 million and $10.0 million, respectively, and were classified in Other assets within the Consolidated Balance
Sheets. For the three months ended March 31, 2012 and 2011, the Companys equity in earnings from its unconsolidated joint ventures totaled $110,000 and $61,000, respectively.
Note 10. Debt and Credit Facilities
The following table presents the composition of the Companys homebuilder debt and its financial services credit facility at March 31, 2012 and December 31, 2011:
At March 31, 2012, the Company had outstanding (a) $167.2 million of 6.9 percent senior notes due June 2013; (b) $126.5 million of 5.4 percent senior notes due January 2015; (c) $230.0 million of 8.4 percent senior notes due May 2017; and (d) $300.0 million of 6.6 percent senior notes due May 2020. Each of the senior notes pays interest semiannually and may be redeemed at a stated redemption price, in whole or in part, at the option of the Company at any time.
To provide letters of credit required in the ordinary course of its business, the Company has various secured letter of credit agreements that require it to maintain restricted cash deposits for outstanding letters of credit. Outstanding letters of credit totaled $60.8 million and $66.0 million under these agreements at March 31, 2012 and December 31, 2011, respectively.
To finance its land purchases, the Company may also use seller-financed nonrecourse secured notes payable. At March 31, 2012 and December 31, 2011, outstanding seller-financed nonrecourse secured notes payable totaled $2.6 million and $3.8 million, respectively.
Senior notes and indenture agreements are subject to certain covenants that include, among other things, restrictions on additional secured debt and the sale of assets. The Company was in compliance with these covenants at March 31, 2012.
In 2011, RMC entered into a $50.0 million repurchase credit facility with JPMorgan Chase Bank, N.A. (JPM). This facility is used to fund, and is secured by, mortgages that were originated by RMC and are pending sale. This facility will expire in December 2012. Under the terms of this facility, RMC is required to maintain various financial and other covenants and to satisfy certain requirements relating to the mortgages securing the facility. At March 31, 2012, the Company was in compliance with these covenants. Outstanding borrowings against this credit facility totaled $32.3 million and $49.9 million at March 31, 2012 and December 31, 2011, respectively.
Note 11. Fair Values of Financial and Nonfinancial Instruments
The Companys financial instruments are held for purposes other than trading. The fair values of these financial instruments are based on quoted market prices, where available, or are estimated using other valuation techniques. Estimated fair values are significantly affected by the assumptions used. As required by ASC No. 820 (ASC 820), Fair Value Measurements and Disclosures, fair value measurements of financial instruments are categorized as Level 1, Level 2 or Level 3, based on the types of inputs used in estimating fair values.
Level 1 fair values are those determined using quoted market prices in active markets for identical assets or liabilities with no valuation adjustments applied. Level 2 fair values are those determined using directly or indirectly observable inputs in the marketplace that are other than Level 1 inputs. Level 3 fair values are those determined using unobservable inputs, including the use of internal assumptions, estimates or models. Valuation of these items is, therefore, sensitive to the assumptions used. Fair values represent the Companys best estimates as of the balance sheet date based on existing conditions and available information at the issuance date of these financial statements. Subsequent changes in conditions or available information may change assumptions and estimates.
The following table sets forth the values and methods used for measuring the fair values of financial instruments on a recurring basis:
Marketable Securities, Available-for-sale
At March 31, 2012 and December 31, 2011, the Company had $290.7 million and $347.0 million, respectively, of marketable securities that were available-for-sale and comprised of U.S. Treasury securities; obligations of U.S. government and local government agencies; corporate debt backed by U.S. government/agency programs; corporate debt securities; asset-backed securities of U.S. government agencies and covered bonds; time deposits; and short-term pooled investments. (See Note 6, Marketable Securities, Available-for-sale.)
Other Financial Instruments
Options on futures contracts are exchange traded and based on quoted market prices (Level 1). Mortgage loans held-for-sale and forward-delivery contracts are based on quoted market prices of similar instruments (Level 2). Interest rate lock commitments (IRLCs) are valued at their aggregate market price premium or deficit, plus a servicing premium, multiplied by the projected close ratio (Level 3). The market price premium or deficit is based on quoted market prices of similar instruments; the servicing premium is based on contractual investor guidelines for each product; and the projected close ratio is determined utilizing an external modeling system,
widely used within the industry, to estimate customer behavior at an individual loan level. At March 31, 2012, contractual principal amounts of mortgage loans held-for-sale totaled $41.2 million, compared to $79.7 million at December 31, 2011. The fair values of mortgage loans held-for-sale, options on futures contracts and IRLCs were included in Other assets within the Consolidated Balance Sheets, and forward-delivery contracts were included in Other assets and Accrued and other liabilities within the Consolidated Balance Sheets. Gains realized on the conversion of IRLCs to loans totaled $3.9 million and $2.6 million for the three-month periods ended March 31, 2012 and 2011, respectively. The Company recognized increases of $545,000 and $1.2 million in the fair value of the pipeline of IRLCs for the three months ended March 31, 2012 and 2011, respectively. Offsetting these items, losses from forward-delivery contracts and options on futures contracts used to hedge IRLCs totaled $520,000 and $207,000 for the three months ended March 31, 2012 and 2011, respectively. Net gains and losses related to forward-delivery contracts, options on futures contracts and IRLCs were included in Financial services revenues within the Consolidated Statements of Earnings.
At March 31, 2012, the excess of the aggregate fair value over the aggregate unpaid principal balance for mortgage loans held-for-sale measured at fair value was $1.0 million. At December 31, 2011, the excess of the aggregate fair value over the aggregate unpaid principal balance for mortgage loans held-for-sale measured at fair value was $2.7 million. These amounts were included in Financial services revenues within the Consolidated Statements of Earnings. At March 31, 2012, the Company held two repurchased loans with payments 90 days or more past due that had an aggregate carrying value of $540,000 and an aggregate unpaid principal balance of $621,000. At December 31, 2011, the Company held two repurchased loans with payments 90 days or more past due that had an aggregate carrying value of $542,000 and an aggregate unpaid principal balance of $623,000.
While recorded fair values represent managements best estimate based on data currently available, future changes in interest rates or in market prices for mortgage loans, among other factors, could materially impact these fair values.
The following table represents a reconciliation of changes in the fair values of Level 3 items (IRLCs) included in Financial services revenues within the Consolidated Statements of Earnings:
In accordance with ASC 820, the Company measures certain nonfinancial homebuilding assets at their fair values on a nonrecurring basis. (See Note 7, Housing Inventories.)
The following table summarizes the fair values of the Companys nonfinancial assets that represent the fair values for communities and other homebuilding assets for which it recognized noncash impairment charges during the reporting periods:
Note 12. Postretirement Benefits
The Company has a supplemental nonqualified retirement plan, which generally vests over five-year periods beginning in 2003, pursuant to which it will pay supplemental pension benefits to key employees upon retirement. In connection with this plan, the Company has purchased cost-recovery life insurance on the lives of certain employees. Insurance contracts associated with the plan are held by trusts established as part of the plan to implement and carry out its provisions and finance its related benefits. The trusts are owners and beneficiaries of such contracts. The amount of coverage is designed to provide sufficient revenue to cover all costs of the plan if assumptions made as to employment term, mortality experience, policy earnings and other factors are realized. At March 31, 2012, the cash surrender value of these contracts was $12.1 million, compared to $11.1 million at December 31, 2011, and was included in Other assets within the Consolidated Balance Sheets. The net periodic benefit income of this plan for the three months ended March 31, 2012, totaled $706,000, which included service costs of $30,000 and interest costs of $200,000, offset by an investment gain of $936,000. The net periodic benefit cost for the three months ended March 31, 2011, totaled $143,000, which included service costs of $262,000 and interest costs of $183,000, offset by an investment gain of $302,000. The $11.6 million and $11.3 million projected benefit obligations at March 31, 2012 and December 31, 2011, respectively, were equal to the net liabilities recognized in the Consolidated Balance Sheets at those dates. The discount rate used for the plan was 7.0 percent for the quarters ended March 31, 2012 and 2011.
Note 13. Income Taxes
Deferred tax assets are recognized for estimated tax effects that are attributable to deductible temporary differences and tax carryforwards related to tax credits and operating losses. They are realized when existing temporary differences are carried back to a profitable year(s) and/or carried forward to a future year(s) having taxable income. Deferred tax assets are reduced by a valuation allowance if an assessment of their components indicates that it is more likely than not that all or some portion of the deferred tax asset will not be realized. This assessment considers, among other things, cumulative losses; forecasts of future profitability; the duration of statutory carryforward periods; the Companys experience with loss carryforwards not expiring unused; and tax planning alternatives. The Company generated deferred tax assets in the first quarters of 2012 and 2011 primarily due to inventory impairments and net operating loss carryforwards. In light of these additional impairments, the unavailability of net operating loss carrybacks and the uncertainty as to the housing downturns duration, which
limits the Companys ability to predict future taxable income, the Company determined that an allowance against its deferred tax assets was required. Therefore, in accordance with ASC No. 740 (ASC 740), Income Taxes, the Company recorded a net valuation allowance totaling $2.0 million against its deferred tax assets during the quarter ended March 31, 2012, which was reflected as a noncash charge to income tax expense. The balance of the deferred tax valuation allowance totaled $272.5 million and $270.5 million at March 31, 2012 and December 31, 2011, respectively. To the extent that the Company generates sufficient taxable income in the future to utilize the tax benefits of related deferred tax assets, it expects to experience a reduction in its effective tax rate as the valuation allowance is reversed. For federal purposes, net operating losses can be carried forward 20 years; for state purposes, they can generally be carried forward 10 to 20 years, depending on the taxing jurisdiction. The federal net operating loss carryforwards, if not utilized, will begin to expire in 2030. Tax credit carryforwards can be carried forward 5 years, with expiration dates beginning in 2013.
For the quarter ended March 31, 2012, the Companys effective income tax benefit rate was 0.0 percent due to a noncash charge of $2.0 million for the Companys deferred tax valuation allowance, which offsets the tax benefit generated during the quarter. For the quarter ended March 31, 2011, the Companys effective income tax benefit rate was 10.9 percent due to a noncash charge of $6.1 million for the Companys deferred tax valuation allowance and to a $2.4 million benefit attributable to the settlement of a previously reserved unrecognized tax benefit.
Note 14. Stock-Based Compensation
The Ryland Group, Inc. 2011 Equity and Incentive Plan (the Plan) permits the granting of stock options, restricted stock awards, stock units, cash incentive awards or any combination of the foregoing to employees. At March 31, 2012 and December 31, 2011, stock options or other awards or units available for grant under the Plan or its predecessor plans totaled 2,559,240 and 3,346,508, respectively.
The Ryland Group, Inc. 2011 Non-Employee Director Stock Plan (the Director Plan) provides for a stock award of 3,000 shares to each non-employee director on May 1 of each year. New non-employee directors will receive a pro rata stock award 30 days after their date of appointment or election based on the remaining portion of the plan year in which they are appointed or elected. Stock awards are fully vested and nonforfeitable on their applicable award dates. There were 176,000 stock awards available for future grant in accordance with the Director Plan at March 31, 2012 and December 31, 2011. Previously, The Ryland Group, Inc. 2004 Non-Employee Director Equity Plan and its predecessor plans provided for automatic grants of nonstatutory stock options to directors. These stock options are fully vested and have a maximum term of ten years.
All outstanding stock options, stock awards and restricted stock awards have been granted in accordance with the terms of the applicable Plan, Director Plan and their respective predecessor plans, all of which were approved by the Companys stockholders. Certain option and share awards provide for accelerated vesting if there is a change in control (as defined in the plans).
The Company recorded stock-based compensation expense of $3.5 million and $2.2 million for the three months ended March 31, 2012 and 2011, respectively. Stock-based compensation expenses have been allocated to the Companys business units and included in Corporate, Financial services and Selling, general and administrative expenses within the Consolidated Statements of Earnings.
A summary of stock option activity in accordance with the Companys equity incentive plans as of March 31, 2012 and 2011, and changes for the three-month periods then ended, follows:
Stock-based compensation expense related to employee stock options totaled $1.1 million and $1.0 million for the three-month periods ended March 31, 2012 and 2011, respectively.
During the quarters ended March 31, 2012 and 2011, the total intrinsic values of stock options exercised were $102,000 and $256,000, respectively. The intrinsic value of a stock option is the amount by which the market value of the underlying stock exceeds the exercise price of the option.
Compensation expense associated with restricted stock unit awards to senior executives totaled $2.3 million and $1.1 million for the three-month periods ended March 31, 2012 and 2011, respectively.
The following is a summary of activity related to restricted stock unit awards:
At March 31, 2012, the outstanding restricted stock units are expected to vest as follows: 201255,493; 2013344,189; 2014235,188; and 2015122,000.
The Company has granted stock awards to its non-employee directors pursuant to the terms of the Director Plan. The Company recorded stock-based compensation expense related to Director Plan stock awards in the amounts of $81,000 and $108,000 for the three-month periods ended March 31, 2012 and 2011, respectively.
Note 15. Commitments and Contingencies
In the ordinary course of business, the Company acquires rights under option agreements to purchase land or lots for use in future homebuilding operations. At March 31, 2012 and December 31, 2011, it had cash deposits and letters of credit outstanding that totaled $51.4 million and $51.9 million, respectively, pertaining to land and lot option purchase contracts with aggregate purchase prices of $509.9 million and $407.6 million, respectively. At March 31, 2012 and December 31, 2011, the Company had $1.1 million and $1.0 million, respectively, in commitments with respect to option contracts having specific performance provisions.
IRLCs represent loan commitments with customers at market rates generally up to 180 days before settlement. The Company had outstanding IRLCs with notional amounts that totaled $139.8 million and $114.6 million at March 31, 2012 and December 31, 2011, respectively. Hedging instruments, including forward-delivery contracts, are utilized to hedge the risks associated with interest rate fluctuations on IRLCs.
As an on-site housing producer, the Company is often required by some municipalities to obtain development or performance bonds and letters of credit in support of its contractual obligations. At March 31, 2012, development bonds totaled $93.3 million, while performance-related cash deposits and letters of credit totaled $47.8 million. At December 31, 2011, development bonds totaled $93.9 million, while performance-related cash deposits and letters of credit totaled $37.2 million. In the event that any such bonds or letters of credit are called, the Company would be required to reimburse the issuer; however, it does not believe that any currently outstanding bonds or letters of credit will be called.
Substantially all of the loans the Company originates are sold within a short period of time in the secondary mortgage market on a servicing-released basis. After the loans are sold, ownership, credit risk and management, including servicing of the loans, passes to the third-party purchaser. RMC retains no role or interest other than standard industry representations and warranties. The Company retains potential liability for possible claims by purchasers of the loans that it breached certain limited standard industry representations and warranties in its sale agreements. There has been an increased industrywide effort by purchasers of the loans to defray losses from purchased mortgages in an unfavorable economic environment by claiming to have found inaccuracies related to sellers representations and warranties in particular sale agreements. There is industry debate regarding the extent to which such claims are justified. The significant majority of these claims relate to loans originated in 2005, 2006 and 2007, when underwriting standards were less stringent.
The following table summarizes the composition of the Companys mortgage loan types originated, its homebuyers average credit scores and its loan-to-value ratios:
While the Companys access to delinquency information is limited subsequent to loan sale, based on a review of information provided voluntarily by certain investors and on government loan reports made available by the U.S. Department of Housing and Urban Development, the Company believes that the average delinquency rates of RMCs loans are generally in line with industry averages. Delinquency rates for loans originated in 2008 and subsequent years are significantly lower than those originated in 2005 through 2007. The Company primarily attributes this decrease in delinquency rates to the industrywide tightening of credit standards and the elimination of most nontraditional loan products.
The Companys mortgage operations have established reserves for possible losses associated with mortgage loans previously originated and sold to investors based upon, among other things, actual past repurchases and losses through the disposition of affected loans; an analysis of repurchase requests received and the validity of those requests; and an estimate of potential liability for valid claims not yet received. Although the amount of an ultimate loss cannot be reasonably estimated, the Company has accrued $9.8 million for these types of claims as of March 31, 2012, but it may have additional exposure. (See Part I, Item 3, Legal Proceedings.)
The following table represents the changes in the Companys mortgage loan loss and related legal reserves during the three-month periods presented:
Subsequent changes in conditions or available information may change assumptions and estimates. Mortgage loan loss reserves and related legal reserves were reflected in Accrued and other liabilities within the Consolidated Balance Sheets, and their associated expenses were included in Financial services expense within the Consolidated Statements of Earnings.
The Company provides product warranties covering workmanship and materials for one year, certain mechanical systems for two years and structural systems for ten years. It estimates and records warranty liabilities based upon historical experience and known risks at the time a home closes as a component of cost of sales, as well as upon identification and quantification of the obligations in cases of unexpected claims. Actual future warranty costs could differ from current estimates.
The following table summarizes the changes in the Companys product liability reserves during the three-month periods presented:
The Company requires substantially all of its subcontractors to have workers compensation insurance and general liability insurance, including construction defect coverage. RHIC provided insurance services to the homebuilding segments subcontractors in certain markets until June 1, 2008. RHIC insurance reserves may have the effect of lowering the Companys product liability reserves, as collectibility of claims against subcontractors enrolled in the RHIC program is generally higher. At March 31, 2012 and December 31, 2011, RHIC had $17.8 million and $18.2 million, respectively, in subcontractor product liability reserves, which were included in Accrued and other liabilities within the Consolidated Balance Sheets. Reserves for loss and loss adjustment expense are based upon industry trends and the Companys annual actuarial projections of historical loss development.
The following table displays the changes in RHICs insurance reserves during the three-month periods presented:
Expense provisions or adjustments to RHICs insurance reserves were included in Financial services expense within the Consolidated Statements of Earnings.
The Company is party to various legal proceedings generally incidental to its businesses. Litigation reserves have been established based on discussions with counsel and the Companys analysis of historical claims. The Company has, and requires its subcontractors to have, general liability insurance to protect it against a portion of its risk of loss and to cover it against construction-related claims. The Company establishes reserves to cover its self-insured retentions and deductible amounts under those policies. Due to the high degree of judgment required in determining these estimated reserve amounts and to the inherent variability in predicting future settlements and judicial decisions, actual future litigation costs could differ from the Companys current estimates. The Company believes that adequate provisions have been made for the resolution of all known claims and pending litigation for probable losses. At March 31, 2012 and December 31, 2011, the Company had legal reserves of $16.0 million and $16.5 million, respectively. (See Part II, Item 1, Legal Proceedings.)
Note 16. New Accounting Pronouncements
In May 2011, the FASB issued Accounting Standards Update (ASU) No. 2011-04 (ASU 2011-04), Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. ASU 2011-04 revises the language used to describe the requirements in U.S. generally accepted accounting principles (GAAP) for measuring fair value and for disclosing information about these
measurements in order to improve consistency in the application and description of fair value between GAAP and International Financial Reporting Standards (IFRS). ASU 2011-04 clarifies how the concepts of highest and best use and valuation premise in a fair value measurement are relevant only when measuring the fair value of nonfinancial assets and are not relevant when measuring the fair value of financial assets or liabilities. In addition, the guidance expanded the unobservable input disclosures for Level 3 fair value measurements, requiring that quantitative information be disclosed in relation to (a) the valuation processes used; (b) the sensitivity of the fair value measurement to changes in unobservable inputs and to interrelationships between those unobservable inputs; and (c) the use of a nonfinancial asset in a way that differs from the assets highest and best use. ASU 2011-04 is effective for interim and annual periods beginning after December 15, 2011. The Companys adoption of ASU 2011-04 did not have a material impact on its consolidated financial statements.
ASU 2011-05 and ASU 2011-12
In June 2011, the FASB issued ASU No. 2011-05 (ASU 2011-05), Presentation of Comprehensive Income. The amendments in ASU 2011-05 allow an entity the option to present the total of comprehensive income, components of net income, and components of other comprehensive income in either a single continuous statement of comprehensive income or in two separate but consecutive statements. Both options require an entity to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income, and a total amount for comprehensive income. ASU 2011-05 eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders equity. The amendments in ASU 2011-05 do not change the items that must be reported in other comprehensive income or specify when an item of other comprehensive income must be reclassified to net income. However, in December 2011, the FASB issued ASU No. 2011-12 (ASU 2011-12), Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05, which deferred the guidance on whether to require entities to present reclassification adjustments out of accumulated other comprehensive income by component in both the statement where net income is presented and the statement where other comprehensive income is presented for both interim and annual financial statements. ASU 2011-12 reinstated the requirements for the presentation of reclassifications that were in place prior to the issuance of ASU 2011-05 and did not change the effective date for ASU 2011-05. ASU 2011-05 and ASU 2011-12 should be applied retrospectively. They are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. The Companys adoption of this guidance did not have a material impact on its consolidated financial statements.
In December 2011, the FASB issued ASU No. 2011-11 (ASU 2011-11), Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities. The amendments in ASU 2011-11 will enhance disclosures required by GAAP by requiring improved information about financial and derivative instruments that are either (a) offset in accordance with Section 210-20-45 or Section 815-10-45 or (b) subject to an enforceable master netting arrangement or similar agreement, irrespective of whether they are offset in accordance with Section 210-20-45 or Section 815-10-45. This information will enable users of an entitys financial statements to evaluate the effect or potential effect of netting arrangements on an entitys financial position, including the effect or potential effect of rights of setoff associated with certain financial instruments and derivative instruments in the scope of this update. An entity is required to apply the amendments for annual reporting periods beginning on or after January 1, 2013, and for interim periods within those annual periods. An entity should provide the disclosures required by those amendments retrospectively for all comparative periods presented. The Company does not anticipate that the adoption of this guidance will have a material impact on its consolidated financial statements.
Note 17. Supplemental Guarantor Information
The Companys obligations to pay principal, premium, if any, and interest under its 6.9 percent senior notes due June 2013; 5.4 percent senior notes due January 2015; 8.4 percent senior notes due May 2017; and 6.6 percent senior notes due May 2020 are guaranteed on a joint and several basis by substantially all of its 100 percent-owned homebuilding subsidiaries (the Guarantor Subsidiaries). Such guarantees are full and unconditional.
In lieu of providing separate financial statements for the Guarantor Subsidiaries, the accompanying condensed consolidating financial statements have been included. Management does not believe that separate financial statements for the Guarantor Subsidiaries are material to investors and are, therefore, not presented.
The following information presents the consolidating statements of earnings, financial position and cash flows for (a) the parent company and issuer, The Ryland Group, Inc. (TRG, Inc.); (b) the Guarantor Subsidiaries; (c) the non-Guarantor Subsidiaries; and (d) the consolidation eliminations used to arrive at the consolidated information for The Ryland Group, Inc. and subsidiaries.
CONSOLIDATING STATEMENTS OF EARNINGS
CONSOLIDATING BALANCE SHEETS