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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

(Mark One)

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

 

For the quarterly period ended June 30, 2016

 

OR

 

 

For the transition period from N/A to

 

Commission file number 1-10959

 

CALATLANTIC GROUP, INC.

(Exact name of registrant as specified in its charter)

 

 

Delaware	33-0475989
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
15360 Barranca Parkway, Irvine, CA (Address of principal executive offices)	92618-2215 (Zip Code)

 

(949) 789-1600

(Registrant’s telephone number, including area code)

 

 

Large accelerated filer x	Accelerated filer ¨
Non-accelerated filer ¨ (Do not check if a smaller reporting company)	Smaller reporting company ¨

 

Registrant's shares of common stock outstanding at July 28, 2016: 118,398,641

CALATLANTIC GROUP, INC.

FORM 10-Q

INDEX

 

-1-

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PART I.   FINANCIAL INFORMATION

ITEM 1.     FINANCIAL STATEMENTS

CALATLANTIC GROUP, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

 

The accompanying notes are an integral part of these condensed consolidated statements.

CALATLANTIC GROUP, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

 

	Three Months Ended June 30,						Six Months Ended June 30,
	2016			2015			2016			2015
	(Dollars in thousands)
	(Unaudited)
Net income	$	112,760		$	57,198		$	185,421		$	88,803
Other comprehensive income, net of tax:
Unrealized gain on marketable securities, available for sale		―			―			39			―
Total comprehensive income	$	112,760		$	57,198		$	185,460		$	88,803

 

The accompanying notes are an integral part of these condensed consolidated statements.

CALATLANTIC GROUP, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

 

The accompanying notes are an integral part of these condensed consolidated balance sheets.

CALATLANTIC GROUP, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

 

		Six Months Ended June 30,
		2016				2015
		(Dollars in thousands)
		(Unaudited)
Cash Flows From Operating Activities:
Net income		$	185,421			$	88,803
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
(Income) loss from unconsolidated joint ventures			(1,412	)			502
Depreciation and amortization			27,428				14,982
Amortization of stock-based compensation			7,512				5,084
Excess tax benefits from share-based payment arrangements			―				(6,363	)
Deferred income tax provision			4,315				49,198
Other operating activities			97				626
Changes in cash and equivalents due to:
Mortgage loans held for sale			136,903				65,182
Inventories - owned			(271,304	)			(341,894	)
Inventories - not owned			(19,254	)			(12,061	)
Other assets			(1,758	)			5,877
Accounts payable			24,080				34,634
Accrued liabilities			(28,414	)			(15,767	)
Net cash provided by (used in) operating activities			63,614				(111,197	)
Cash Flows From Investing Activities:
Investments in unconsolidated homebuilding joint ventures			(22,592	)			(20,778	)
Distributions of capital from unconsolidated homebuilding joint ventures			8,115				8,760
Other investing activities			(4,166	)			(12,022	)
Net cash provided by (used in) investing activities			(18,643	)			(24,040	)
Cash Flows From Financing Activities:
Change in restricted cash			6,063				(1,242	)
Borrowings from revolving credit facility			693,700				158,900
Principal payments on revolving credit facility			(693,700	)			(128,900	)
Principal payments on secured project debt and other notes payable			(10,169	)			(497	)
Proceeds from the issuance of senior notes payable			300,000				―
Payment of debt issuance costs			(2,195	)			―
Net proceeds from (payments on) mortgage credit facilities			(128,908	)			928
Repurchases of common stock			(99,829	)			(22,073	)
Common stock dividend payments			(9,527	)			―
Issuance of common stock under employee stock plans, net of tax withholdings			1,069				(2,322	)
Excess tax benefits from share-based payment arrangements			―				6,363
Other financing activities			(199	)			―
Net cash provided by (used in) financing activities			56,305				11,157
Net increase (decrease) in cash and equivalents			101,276				(124,080	)
Cash and equivalents at beginning of period			186,594				212,393
Cash and equivalents at end of period		$	287,870			$	88,313
Cash and equivalents at end of period		$	287,870			$	88,313
Homebuilding restricted cash at end of period			30,833				39,714
Financial services restricted cash at end of period			22,008				1,045
Cash and equivalents and restricted cash at end of period		$	340,711			$	129,072

 

The accompanying notes are an integral part of these condensed consolidated statements.

CALATLANTIC GROUP, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2016

 

The accompanying condensed consolidated financial statements include the accounts of CalAtlantic Group, Inc. and its wholly owned subsidiaries and have been prepared without audit, pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC") for Form 10-Q.  Certain information normally included in the annual financial statements prepared in accordance with U.S. generally accepted accounting principles ("GAAP") has also been omitted pursuant to applicable rules and regulations.   In the opinion of management, the unaudited condensed consolidated financial statements included herein reflect all adjustments, which include only normal recurring adjustments, necessary to present fairly our financial position as of June 30, 2016 and the results of operations and cash flows for the periods presented.

Certain items in the prior period condensed consolidated financial statements have been reclassified to conform with the current period presentation, including per share related information.

The unaudited condensed consolidated financial statements included herein should be read in conjunction with the audited consolidated financial statements and notes thereto included in our Annual Report on Form 10‑K for the year ended December 31, 2015.  Unless the context otherwise requires, the terms "we," "us," "our" and "the Company" refer to CalAtlantic Group, Inc. and its subsidiaries.  The results of operations for interim periods are not necessarily indicative of results to be expected for the full year.

2.      Recent Accounting Pronouncements

 

In May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2014-09, Revenue from Contracts with Customers ("ASU 2014-09"), which supersedes existing accounting literature relating to how and when a company recognizes revenue.  Under ASU 2014-09, a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods and services.  In August 2015, the FASB issued ASU No. 2015-14, Revenue from Contracts with Customers (Topic 606):  Deferral of the Effective Date, which delayed the effective date of ASU 2014-09 by one year.  As a result, for public companies, ASU 2014-09 will be effective for annual reporting periods and interim periods within those annual periods beginning after December 15, 2017, and is to be applied either with a full retrospective or modified retrospective approach, with early application permitted.  We are currently evaluating the impact the adoption will have on our condensed consolidated financial statements and related disclosures.

 

In June 2014, the FASB issued ASU No. 2014-12, Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period ("ASU 2014-12"), which requires that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition.  A reporting entity should apply existing guidance in ASC 718, Compensation — Stock Compensation, as it relates to awards with performance conditions that affect vesting to account for such awards.  The amendments in ASU 2014-12 were effective for annual periods and interim periods within those annual periods beginning after December 15, 2015.  Our adoption of ASU 2014-12 on January 1, 2016 did not have an effect on our financial statements.

 

In August 2014, the FASB issued ASU No. 2014-15, Disclosure of Uncertainties About an Entity's Ability to Continue as a Going Concern ("ASU 2014-15"), which requires management to perform interim and annual assessments on whether there are conditions or events that raise substantial doubt about the entity's ability to continue as a going concern within one year of the date the financial statements are issued and to provide related disclosures, if required.  The amendments in ASU 2014-15 are effective for the

 

annual period ending after December 15, 2016, and for annual and interim periods thereafter.  Early adoption is permitted.  Our adoption of ASU 2014-15 is not expected to have a material effect on our financial statements and related disclosures.

 

In February 2015, the FASB issued ASU No. 2015-02, Amendments to the Consolidation Analysis ("ASU 2015-02"), which changes the analysis that a reporting entity must perform to determine whether it should consolidate certain types of legal entities. The amendments in ASU 2015-02 were effective for annual periods and interim periods within those annual periods beginning after December 15, 2015.  Our adoption of ASU 2015-02 on January 1, 2016 did not have a material effect on our financial statements and related disclosures.

 

In September 2015, the FASB issued ASU No. 2015-16, Simplifying the Accounting for Measurement-Period Adjustments ("ASU 2015-16"), which eliminates the requirement that an acquirer in a business combination account for measurement-period adjustments retrospectively.  Instead, an acquirer will recognize a measurement-period adjustment during the period in which it determines the amount of the adjustment, including the effect on earnings of any amounts it would have recorded in previous periods if the accounting had been completed at the acquisition date.  ASU 2015-16 was effective for annual periods and interim periods within those annual periods beginning after December 15, 2015.  Our adoption of ASU 2015-16 on January 1, 2016 did not have a material effect on our financial statements.

In January 2016, the FASB issued ASU 2016-01, Financial Instruments - Overall: Recognition and Measurement of Financial Assets and Financial Liabilities ("ASU 2016-01"), which modifies how entities measure equity investments and present changes in the fair value of financial liabilities. Under the new guidance, entities will have to measure equity investments that do not result in consolidation and are not accounted under the equity method at fair value and recognize any changes in fair value in net income unless the investments qualify for the new practicality exception.  A practicality exception will apply to those equity investments that do not have a readily determinable fair value and do not qualify for the practical expedient to estimate fair value under ASC Topic 820, Fair Value Measurements, and as such these investments may be measured at cost.  ASU 2016-01 is effective for annual periods and interim periods within those annual periods beginning after December 15, 2017.  We are currently evaluating the impact adoption will have on our financial statements.

 

In March 2016, the FASB issued ASU 2016-02, Leases ("ASU 2016-02"), which provides guidance for accounting for leases. ASU 2016-02 requires lessees to classify leases as either finance or operating leases and to record a right-of-use asset and a lease liability for all leases with a term greater than 12 months regardless of the lease classification.  The lease classification will determine whether the lease expense is recognized based on an effective interest rate method or on a straight line basis over the term of the lease. Accounting for lessors remains largely unchanged from current GAAP.  ASU 2016-02 is effective for annual periods and interim periods within those annual periods beginning after December 15, 2018.  We are currently evaluating the impact adoption will have on our financial statements.

 

In March 2016, the FASB issued ASU 2016-07, Investments- Equity Method and Joint Ventures: Simplifying the Transition to the Equity Method of Accounting ("ASU 2016-07"), which eliminates the requirement to apply the equity method of accounting retrospectively when a reporting entity obtains significant influence over a previously held investment.  ASU 2016-07 is effective for annual periods and interim periods within those annual periods beginning after December 15, 2016.  Our adoption of ASU 2016-07 is not expected to have a material effect on our financial statements.

 

In March 2016, the FASB issued ASU 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net) ("ASU 2016-08").  ASU 2016-08 does not change the core principle of the guidance stated in ASU 2014-09, instead, the amendments in this ASU are intended to improve the operability and understandability of the implementation guidance on principal versus agent considerations and whether an entity reports revenue on a gross or net basis.  ASU 2016-08 will have the same effective date and transition requirements as the new

 

revenue standard issued in ASU 2014-09.  We are currently evaluating the impact the adoption of this ASU and ASU 2014-09 will have on our financial statements and related disclosures.

 In March 2016, the FASB issued ASU No. 2016-09, Compensation — Stock Compensation: Improvements to Employee Share-Based Payment Accounting ("ASU 2016-09"), which simplifies several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows.  ASU 2016-09 is effective for annual periods and interim periods within those annual periods beginning after December 15, 2016, and early adoption is permitted.  We are currently evaluating the impact adoption will have on our financial statements.

On October 1, 2015, pursuant to the terms and conditions of the Amended and Restated Agreement and Plan of Merger, dated as of June 14, 2015 (the "Merger Agreement"), between Standard Pacific Corp. ("Standard Pacific") and The Ryland Group, Inc. ("Ryland"), Ryland merged with and into Standard Pacific (the "Merger"), with Standard Pacific continuing as the surviving corporation.  At the same time Standard Pacific changed its name to CalAtlantic Group, Inc.  Based on an evaluation of the provisions of ASC Topic 805, Business Combinations ("ASC 805"), Standard Pacific was determined to be the acquirer for accounting purposes.  Under ASC 805, Standard Pacific is treated as having acquired Ryland in an all-stock transaction for an estimated total purchase price of approximately $2.0 billion.  The estimated total purchase price was preliminarily allocated to Ryland's assets and liabilities based upon fair values as determined by the Company, as follows (in thousands):

 

 

During the 2016 first quarter the Company completed a valuation of the 1.625% convertible senior notes assumed in the merger with Ryland and determined that the value associated with the conversion feature was $93.8 million, which is included in additional paid-in capital in the accompanying condensed consolidated balance sheet as of June 30, 2016.  In connection with the valuation of the conversion feature, the related deferred tax asset was reduced by approximately $35.9 million, with a corresponding increase in goodwill.  The purchase price accounting reflected in the accompanying financial statements is preliminary and is based upon estimates and assumptions that are subject to change within the measurement period (up to one year from the acquisition date pursuant to ASC 805) that may impact the fair value of the assets and liabilities above (including inventories, deferred income taxes, other assets and accrued liabilities). The $969.0 million of goodwill represents the excess of the purchase price over the fair value of assets acquired and liabilities assumed, and it is not deductible for income tax purposes.  As of the end of the period covered by this quarterly report on Form 10-Q, the allocation of goodwill to our reporting units is considered preliminary, as it is based upon estimates and assumptions that are subject to change within the measurement period.

The following presents summarized unaudited supplemental pro forma operating results as if Ryland had been included in the Company's Condensed Consolidated Statements of Operations as of January 1, 2015.

 

 

The supplemental pro forma operating results have been determined after adjusting the operating results of Ryland to reflect additional amortization that would have been recorded assuming the fair value adjustment to intangible assets had been applied beginning January 1, 2015. Certain other adjustments, including those related to conforming accounting policies and adjusting acquired inventory to fair value, have not been reflected in the supplemental pro forma operating results due to the impracticability of estimating such impacts.

We operate two principal businesses: homebuilding and financial services.

 

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 Topic 280, Segment Reporting ("ASC 280"), our homebuilding operating segments have been grouped into four reportable segments: North, consisting of our operating divisions in Georgia, Delaware, Illinois, Indiana, Maryland, Minnesota, New Jersey, Pennsylvania, Virginia and Washington D.C.; Southeast, consisting of our operating divisions in Florida and the Carolinas; Southwest, consisting of our operating divisions in Texas, Colorado and Nevada; and West, consisting of our operating divisions in California and Arizona.   During the 2015 third quarter, in connection with transition planning related to the Merger, the chief operating decision makers began evaluating the business and allocating resources based on aggregating our Arizona operating segment within our California reportable segment (and renamed the California segment the "West" segment).  Our Arizona operating segment was previously reported within our Southwest reportable segment, and as such, prior periods presented have been restated to conform to our new presentation. In addition, upon completion of the Merger with Ryland on October 1, 2015, we created the new North segment as we did not have operating divisions in those geographic areas.

 

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 various title services for our homebuyers in most of our operating divisions.  Our mortgage financing and title services operations are included in our financial services reportable segment, which is separately reported in our condensed 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.  All of the expenses incurred by Corporate are allocated to each of our operating divisions based on their respective percentage of revenues.

Segment financial information relating to the Company's homebuilding operations was as follows:

 

 

Segment financial information relating to the Company's homebuilding assets was as follows:

 

__________________

(1)

The assets in our Corporate Segment include cash and cash equivalents and our deferred tax asset, and at December 31, 2015 included goodwill recorded in connection with our merger with Ryland.  During the 2016 second quarter, recorded goodwill was allocated to the Company's reporting units (as of June 30, 2016, approximately $0.3 billion was included in each of the North, Southeast and Southwest segments, and approximately $0.1 billion was included in the West region).  As of the end of the period covered by this quarterly report on Form 10-Q, the allocation of goodwill to our reporting units is considered preliminary, as it is based upon estimates and assumptions that are subject to change within the measurement period.

We compute earnings per share in accordance with ASC Topic 260, Earnings per Share ("ASC 260"), which requires earnings per share for each class of stock (common stock and participating preferred stock) to be calculated using the two-class method.  The two-class method is an allocation of earnings between the holders of common stock and a company's participating security holders.  Under the two-class method, earnings for the reporting period are allocated between common shareholders and other security holders based on their respective participation rights in undistributed earnings.  Unvested share-based payment awards that contain non-forfeitable rights to dividends or dividend equivalents are participating securities and, therefore, are included in computing earnings per share pursuant to the two-class method.

Basic earnings per common share is computed by dividing income or loss available to common stockholders by the weighted average number of shares of basic common stock outstanding.  Our Series B junior participating convertible preferred stock ("Series B Preferred Stock"), which was convertible into shares of our common stock at the holder's option, and our unvested restricted stock, are classified as participating securities in accordance with ASC 260.  Net income allocated to the holders of our Series B Preferred Stock and unvested restricted stock is calculated based on the shareholders' proportionate share of weighted average shares of common stock outstanding on an if-converted basis.

For purposes of determining diluted earnings per common share, basic earnings per common share is further adjusted to include the effect of potential dilutive common shares outstanding, including stock options, stock appreciation rights, performance share awards and unvested restricted stock using the more

 

dilutive of either the two-class method or the treasury stock method, and Series B Preferred Stock and convertible debt using the if-converted method.  Under the two-class method of calculating diluted earnings per share, net income is reallocated to common stock, the Series B Preferred stock and all dilutive securities based on the contractual participating rights of the security to share in the current earnings as if all of the earnings for the period had been distributed.  In the computation of diluted earnings per share, the two-class method and if-converted method for the Series B Preferred Stock resulted in the same earnings per share amounts as the holder of the Series B Preferred Stock had the same economic rights as the holders of the common stock.

In connection with the closing of the Merger with Ryland on October 1, 2015, the Company effected a reverse stock split such that each five shares of common stock of Standard Pacific common stock issued and outstanding immediately prior to the closing of the Merger were combined and converted into one issued and outstanding share of common stock of the Company.  As required in accordance with GAAP, all share and earnings per share information noted below have been retroactively adjusted to reflect the reverse stock split. The following table sets forth the components used in the computation of basic and diluted income per share.

 

 

We account for share-based awards in accordance with ASC 718 which requires that the cost resulting from all share-based payment transactions be recognized in the financial statements.  ASC 718 requires all entities to apply a fair value-based measurement method in accounting for share-based payment transactions with employees except for equity instruments held by employee share ownership plans.

Total compensation expense recognized related to stock-based compensation was $3.7 million and $2.4 million for the three months ended June 30, 2016 and 2015, respectively.  For the six months ended June 30, 2016 and 2015, we recognized stock-based compensation expense of $7.5 million and $5.1 million, respectively.  As of June 30, 2016, total unrecognized stock-based compensation expense was

 

$27.3 million, with a weighted average period over which the remaining unrecognized compensation expense is expected to be recorded of approximately 2.2 years.

Cash and equivalents include cash on hand, demand deposits and all highly liquid short-term investments, including interest-bearing securities purchased with a maturity of three months or less from the date of purchase.  At June 30, 2016, cash and equivalents included $133.6 million of cash from home closings held in escrow for our benefit, typically for less than five days, which are considered deposits in-transit.

At June 30, 2016, homebuilding restricted cash represented $30.8 million of cash held in cash collateral accounts primarily related to certain letters of credit that have been issued.  Financial services restricted cash as of June 30, 2016 consisted of $17.7 million held in cash collateral accounts primarily related to certain letters of credit that have been issued, $3.5 million related to our financial services subsidiary mortgage credit facilities and $0.8 million related to funds held in trust for third parties.

8.  Marketable Securities, Available-for-sale

The Company's investment portfolio includes mainly municipal debt securities and metropolitan district bond securities, which are included in homebuilding other assets in the accompanying condensed consolidated balance sheets.  As defined in ASC Topic 320, Investments—Debt and Equity Securities ("ASC 320"), the Company considers its investment portfolio to be available-for-sale.  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 are included in accumulated other comprehensive income (loss), net of tax, within stockholders' equity.  At June 30, 2016, accumulated other comprehensive income included unrealized gains of $392,000 on available-for-sale marketable securities, offset with reclassification adjustments, which represent net realized earnings associated with the Company's investment portfolio, which included interest, dividends and net realized gains on sales of marketable securities, and totaled $174,000 and $348,000 for the three and six months ended June 30, 2016, respectively.  Realized gains or losses were included in homebuilding other income (expense) in the accompanying condensed consolidated statements of operations.

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 June 30, 2016, the Company believes that the cost bases for its available-for-sale securities were recoverable in all material respects.

The primary objectives of the Company's 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 Company's investment policy limits investments to debt securities 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.  Our policy places restrictions on maturities, as well as on concentration by type and issuer.

The following table displays the fair values of marketable securities, available-for-sale, by type of security:

          

The following table displays the fair values of marketable securities, available-for-sale, by contractual maturity:

 

 

 

  

  

a.  Inventories Owned

 

Inventories owned consisted of the following at:

 

 

In accordance with ASC Topic 360, Property, Plant, and Equipment ("ASC 360"), we record impairment losses on inventories when events and circumstances indicate that they may be impaired, and the future undiscounted cash flows estimated to be generated by those assets are less than their carrying amounts.  Inventories that are determined to be impaired are written down to their estimated fair value.  We calculate the fair value of a project under a land residual value analysis and in certain cases in conjunction with a discounted cash flow analysis.  As of June 30, 2016 and 2015, the total active and future projects that we owned were 876 and 381, respectively.  During the six months ended June 30, 2016 and 2015, we reviewed all projects for indicators of impairment and based on our review we did not record any inventory impairments during these periods.

b. Inventories Not Owned

Inventories not owned consisted of the following at:

 

 

Under ASC Topic 810, Consolidation ("ASC 810"), a non-refundable deposit paid to an entity is deemed to be a variable interest that will absorb some or all of the entity's expected losses if they occur.  Our land purchase and lot option deposits generally represent our maximum exposure to the land seller if we elect not to purchase the optioned property.  In some instances, we may also expend funds for due diligence, development and construction activities with respect to optioned land prior to takedown.  Such costs are classified as inventories owned, which we would have to write-off should we not exercise the option.  Therefore, whenever we enter into a land option or purchase contract with an entity and make a non-refundable deposit, a variable interest entity ("VIE") may have been created.  In accordance with ASC 810, we perform ongoing reassessments of whether we are the primary beneficiary of a VIE.

Other lot option contracts as of June 30, 2016 and December 31, 2015 represented purchase price allocated to lot option contracts assumed in connection with a business acquisition during the 2013 third quarter.

We follow the practice of capitalizing interest to inventories owned during the period of development and to investments in unconsolidated homebuilding and land development joint ventures in accordance with ASC Topic 835, Interest ("ASC 835").  Homebuilding interest capitalized as a cost of inventories owned is included in cost of sales as related units or lots are sold.  Interest capitalized to investments in unconsolidated homebuilding and land development joint ventures is included as a reduction of income from unconsolidated joint ventures when the related homes or lots are sold to third parties.  Interest capitalized to investments in unconsolidated land development joint ventures is transferred to inventories owned if the underlying lots are purchased by us.  To the extent our debt exceeds our qualified assets as defined in ASC 835, we expense a portion of the interest incurred by us.  Qualified assets represent projects that are actively selling or under development as well as investments in homebuilding and land development unconsolidated joint ventures.  During the six months ended June 30, 2016 and 2015, our qualified assets exceeded our debt, and as a result, all of our homebuilding interest incurred during the six months ended June 30, 2016 and 2015 was capitalized in accordance with ASC 835.

The following is a summary of homebuilding interest capitalized to inventories owned and investments in unconsolidated joint ventures, amortized to cost of sales and income (loss) from unconsolidated joint ventures and expensed as interest expense, for the three and six months ended June 30, 2016 and 2015:

 

__________________

(1)	Total interest incurred and interest capitalized to inventories owned during the six months ended June 30, 2016 includes a $9 million increase related to the valuation of the 1.625% convertible senior notes that was completed during the 2016 first quarter.  Please see Note 3 for further discussion.

(2)	During the three and six months ended June 30, 2016, in connection with lot purchases from our joint ventures, $0.6 million of capitalized interest was transferred from investments in unconsolidated joint ventures to inventories owned.

The table set forth below summarizes the condensed combined statements of operations for our unconsolidated land development and homebuilding joint ventures that we account for under the equity method:

 

Income (loss) from unconsolidated joint ventures reflected in the accompanying condensed consolidated statements of operations represents our share of the income (loss) of our unconsolidated land development and homebuilding joint ventures, which is allocated based on the provisions of the underlying joint venture operating agreements less any additional impairments recorded against our investments in joint ventures which we do not deem recoverable.  In addition, we defer recognition of our share of income that relates to lots purchased by us from land development joint ventures until we ultimately sell the homes to be constructed to third parties, at which time we account for these earnings as a reduction of the cost basis of the lots purchased from these joint ventures.  For the six months ended June 30, 2016, income (loss) from unconsolidated joint ventures included $0.8 million of income from our Southwest region joint ventures and $0.4 million of income from our Southeast region joint ventures.  For the six months ended June 30, 2015, income (loss) from unconsolidated joint ventures was primarily attributable to our share of income (loss) related to our West region joint ventures.

During each of the six months ended June 30, 2016 and 2015, all of our investments in unconsolidated joint ventures were reviewed for impairment.  Based on the impairment review, no joint venture projects were determined to be impaired for the six months ended June 30, 2016 or 2015.

The table set forth below summarizes the condensed combined balance sheets for our unconsolidated land development and homebuilding joint ventures that we accounted for under the equity method:

 

 

In some cases our net investment in these unconsolidated joint ventures is not equal to our proportionate share of total equity reflected in the table above primarily because of differences between asset impairments that we recorded in prior periods against our joint venture investments and the impairments recorded by the applicable joint venture.  As of June 30, 2016 and December 31, 2015, substantially all of our investments in unconsolidated joint ventures were in California.  Our investments in unconsolidated joint ventures also included approximately $4.3 million and $2.9 million of homebuilding interest capitalized to investments in unconsolidated joint ventures as of June 30, 2016 and December 31, 2015, respectively, which capitalized interest is not included in the condensed combined balance sheets above.

Our investments in these unconsolidated joint ventures may represent a variable interest in a VIE depending on, among other things, the economic interests of the members of the entity and the contractual terms of the arrangement.  We analyze all of our unconsolidated joint ventures under the provisions of ASC 810 to determine whether these entities are deemed to be VIEs, and if so, whether we are the primary beneficiary.  As of June 30, 2016, all of our homebuilding and land development joint ventures with unrelated parties were determined under the provisions of ASC 810 to be unconsolidated joint ventures either because they were not deemed to be VIEs and we did not have a controlling interest, or, if they were a VIE, we were not deemed to be the primary beneficiary.

Estimated future direct warranty costs are accrued and charged to cost of sales in the period when the related homebuilding revenues are recognized.  Amounts accrued are based upon historical experience.  Indirect warranty overhead salaries and related costs are charged to cost of sales in the period incurred.  We assess the adequacy of our warranty accrual on a quarterly basis and adjust the amounts recorded if necessary.  Our warranty accrual is included in accrued liabilities in the accompanying condensed consolidated balance sheets.

Changes in our warranty accrual are detailed in the table set forth below:

 

 

  

As of June 30, 2016, we were party to a $750 million unsecured revolving credit facility (the "Revolving Facility"), $350 million of which is available for letters of credit, which matures in October 2019.  The Revolving Facility has an accordion feature under which the Company may increase the total commitment up to a maximum aggregate amount of $1.2 billion, subject to certain conditions, including the availability of additional bank commitments.  Interest rates, as defined in the credit agreement, approximate (i) LIBOR (approximately 0.46% at June 30, 2016) plus 1.75%, or (ii) Prime (3.50% at June 30, 2016) plus 0.75%.

In addition to customary representations and warranties, the facility contains financial and other covenants, including a minimum tangible net worth requirement of $1.65 billion (which amount is subject to increase over time based on subsequent earnings and proceeds from equity offerings), a net homebuilding leverage covenant that prohibits the leverage ratio (as defined therein) from exceeding 2.00 to 1.00 and a land covenant that limits land not under development to an amount not to exceed tangible net worth. The Company is also required to maintain either (a) a minimum liquidity level (unrestricted cash in excess of interest incurred for the previous four quarters) or (b) a minimum interest coverage ratio (EBITDA to interest expense, as defined therein) of at least 1.25 to 1.00.  We were in compliance with all of the Revolving Facility covenants as of June 30, 2016. The Revolving Facility also limits, among other things, the Company's investments in joint ventures and the amount of the Company's common stock that the Company can repurchase.  On June 30, 2016, we had no borrowings outstanding under the facility and had outstanding letters of credit issued under the facility totaling $113.4 million, leaving $636.6 million available under the facility to be drawn.

 

As of June 30, 2016, in addition to our $350 million letter of credit sublimit under our Revolving Facility, we were party to four committed letter of credit facilities totaling $48 million, of which $27.3 million was outstanding.  These facilities require cash collateralization and have maturity dates ranging from October 2016 to October 2017.  As of June 30, 2016, these facilities were secured by cash collateral deposits of $27.8 million.  Upon maturity, we may renew or enter into new letter of credit facilities with the same or other financial institutions.

14.  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.  At June 30, 2016, we had approximately $41.1 million outstanding in secured project debt and other notes payable.  

15.  Senior Notes Payable

Senior notes payable consisted of the following at:

 

 

The carrying amount of our senior notes listed above are net of debt issuance costs and any discounts and premiums that are amortized to interest costs over the respective terms of the notes.

 

The Company's 1.625% Convertible Senior Notes due 2018 (the "1.625% 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 1.625% Convertible Notes bear interest at a rate of 1.625% per year and will mature on May 15, 2018, unless earlier converted or repurchased. The holders may convert their 1.625% Convertible Notes at any time into shares of the Company's common stock at a conversion rate of 31.8394 shares of common stock per $1,000 of their principal amount (which is equal to a conversion price of approximately $31.41 per share), subject to adjustment. The Company may not redeem the 1.625% Convertible Notes prior to the stated maturity date.

 

The Company's 0.25% Convertible Senior Notes due 2019 (the "0.25% 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 0.25% Convertible Notes bear interest at a rate of 0.25% per year and will mature on June 1, 2019, unless earlier converted, redeemed or repurchased. The holders may convert their 0.25% Convertible Notes at any time into shares of the Company's common stock at a conversion rate of 13.5966 shares of common stock per $1,000 of their principal amount (which is equal to a conversion price of approximately $73.55 per share), subject to adjustment. The Company may not redeem the 0.25% Convertible Notes prior to June 6, 2017. On or after that date, the Company may redeem for cash any or all of the 0.25% Convertible Notes, at its option, if the closing sale price of its common stock for at least 20 trading days (whether or not consecutive) during any 30 consecutive trading day period ending within 5 trading days immediately preceding the date on which it provides notice of redemption, including the last trading day of such 30 day trading period, exceeds 130 percent of the applicable conversion price on each applicable trading day. The redemption price will equal 100 percent of the principal amount of the 0.25% Convertible Notes to be redeemed, plus accrued and unpaid interest to, but excluding, the redemption date.

 

The Company's 1.25% Convertible Senior Notes due 2032 (the "1.25% 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 1.25% Convertible Notes bear interest at a rate of 1.25% per year and will mature on August 1, 2032, unless earlier converted, redeemed or repurchased. The holders may convert their 1.25% Convertible Notes at any time into shares of the Company's common stock at a conversion rate of 24.8379 shares of common stock per $1,000 of their principal amount (which is equal to a conversion price of approximately $40.26 per share), subject to adjustment. The Company may not redeem the 1.25% Convertible Notes prior to August 5, 2017. On or after August 5, 2017 and prior to the maturity date, the Company may redeem for cash all or part of the 1.25% Convertible Notes at a redemption price equal to 100% of the principal amount of the 1.25% Convertible Notes being redeemed.  On each of August 1, 2017,

 

August 1, 2022 and August 1, 2027, holders of the 1.25% Convertible Notes may require the Company to purchase all or any portion of their 1.25% Convertible Notes for cash at a price equal to 100% of the principal amount of the 1.25% Convertible Notes to be repurchased.

 

Our senior notes payable are all senior obligations and rank equally with our other existing senior indebtedness and, with the exception of our Convertible Notes, are redeemable at our option, in whole or in part, pursuant to a "make whole" formula.  These notes contain various restrictive covenants.  Our 10.75% Senior Notes due September 2016 (the "2016 Notes") 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 billion in 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, stock repurchases 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 June 30, 2016, we were able to incur additional indebtedness and make restricted payments because we satisfied both conditions.  Many of our 100% owned direct and indirect subsidiaries (collectively, the "Guarantor Subsidiaries") guaranty our outstanding senior notes.  The guarantees are full and unconditional, and joint and several.  The indentures entered into prior to our merger with Ryland provide that a Guarantor Subsidiary will be released and relieved of any obligations under the applicable note guarantee in the event (i) of a sale or other disposition (whether by merger, stock purchase, asset sale or otherwise) of a Guarantor Subsidiary to an entity which is not CalAtlantic Group, Inc. or a Guarantor Subsidiary; (ii) the requirements for legal defeasance or covenant defeasance have been satisfied; (iii) a Guarantor Subsidiary ceases to be a restricted subsidiary as the result of the Company owning less than 80% of such Guarantor Subsidiary; (iv) a Guarantor Subsidiary ceases to guarantee all other public notes of the Company; or (v) a Guarantor Subsidiary is designated as an Unrestricted Subsidiary under the indentures for covenant purposes.  The indentures entered into concurrently with the closing of our merger with Ryland provide that a Guarantor Subsidiary will be released and relieved of any obligations under the applicable note guarantee in the event that (in the case of the non-convertible senior notes) such Guarantor Subsidiary ceases to be a restricted subsidiary in the homebuilding segment or (in the case of the convertible senior notes) such Guarantor Subsidiary ceases to guaranty any publicly traded debt securities.  Please see Note 22 for supplemental financial statement information about our guarantor subsidiaries group and non-guarantor subsidiaries group.

 

During the 2016 second quarter, the Company issued $300 million in aggregate principal amount of 5.25% Senior Notes due 2026, which are senior unsecured obligations of the Company and are guaranteed by the guarantors of our other senior notes on a senior unsecured basis.  We intend to use a portion of the net proceeds of this issuance to repay or repurchase our 2016 Notes.

Prior to our merger with Ryland, MP CA Homes, LLC ("MatlinPatterson") held all of the outstanding shares of Company Series B Preferred Stock and 126.4 million shares of Company common stock, which, together, represented approximately 59% of the total number of shares of Company common stock issued and outstanding on an if-converted basis.  Immediately following the merger, MatlinPatterson converted all of their shares of preferred stock into 17.6 million shares of Company common stock.  As of June 30, 2016, MatlinPatterson held 42.8 million shares (approximately 36%) of the Company's outstanding common stock and no shares of preferred stock.

At June 30, 2016, we had $174.5 million outstanding under our mortgage financing subsidiary's mortgage credit facilities.  These mortgage credit facilities consisted of a $300 million uncommitted repurchase facility with one lender, maturing in January 2017, and a $75 million repurchase facility with another lender, which matured in July 2016.  These facilities require our mortgage financing subsidiary to

 

maintain cash collateral accounts, which totaled $3.5 million as of June 30, 2016, and also contain financial covenants which require CalAtlantic Mortgage to, among other things, maintain a 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 June 30, 2016, CalAtlantic Mortgage was in compliance with the financial and other covenants contained in these facilities.

 

As of the date of this filing, CalAtlantic Mortgage is currently negotiating a renewal of the $75 million repurchase facility.

 

ASC Topic 820, Fair Value Measurements and Disclosures ("ASC 820"), establishes a framework for measuring fair value, expands disclosures regarding fair value measurements and defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.  Further, ASC 820 requires us to maximize the use of observable market inputs, minimize the use of unobservable market inputs and disclose in the form of an outlined hierarchy the details of such fair value measurements. ASC 820 specifies a hierarchy of valuation techniques based on whether the inputs to a fair value measurement are considered to be observable or unobservable in a marketplace. The three levels of the hierarchy are as follows:

The following table presents the Company's financial instruments measured at fair value on a recurring basis:

 

 

Marketable Securities, Available-for-sale

Marketable securities that are available-for-sale are comprised mainly of municipal debt securities and metropolitan district bond securities.  The Company's municipal debt securities are valued based on quoted market prices of similar instruments and the metropolitan district bond securities are based on a discounted future cash flow model, which uses Level 3 inputs.  The primary unobservable inputs used in our discounted cash flow model are (1) the forecasted number of homes to be closed, as they drive increases to the taxpaying base for the metro district, (2) the forecasted assessed value of those closed homes and (3) the discount rate.

Mortgage loans held for sale

Mortgage loans held for sale consist of FHA, VA, USDA and agency first mortgages on single-family residences which are eligible for sale to FNMA/FHLMC, GNMA or other investors, as applicable.  Fair values of these loans are based on quoted prices from third party investors when preselling loans.

The following table presents the carrying values and estimated fair values of our other financial instruments for which we have not elected the fair value option in accordance with ASC 825:

 

 

Mortgage Loans Held for Investment – Fair value of these loans is based on the estimated market value of the underlying collateral based on market data and other factors for similar type properties as further adjusted to reflect the estimated net realizable value of carrying the loans through disposition.

Senior Notes Payable – The senior notes are traded over the counter and their fair values were estimated based upon the values of their last trade at the end of the period.

The fair value of our cash and equivalents, restricted cash, accounts payable and other liabilities, secured project debt and other notes payable, and mortgage credit facilities approximate their carrying amounts due to the short-term nature of these assets and liabilities.

 

a.  Land Purchase and Option Agreements

 

We are subject to 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 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 June 30, 2016, we had non-refundable cash deposits outstanding of approximately $69.8 million and capitalized pre-acquisition and other development and construction costs of approximately $10.3 million relating to land purchase and option contracts having a total remaining purchase price of approximately $732.4 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.

 

b.  Land Development and Homebuilding Joint Ventures

 

Our joint ventures have historically obtained secured acquisition, development and construction financing designed to reduce the use of funds from corporate financing sources.  As of June 30, 2016, we held membership interests in 27 homebuilding and land development joint ventures, of which 13 were active and 14 were inactive or winding down.  As of such date, only two joint ventures had project specific debt outstanding, which totaled $30.2 million.  This joint venture bank debt is non-recourse to us and is scheduled to mature in June 2017.  At June 30, 2016, we had no joint venture surety bonds outstanding.

 

c.  Surety Bonds

 

We obtain surety bonds in the normal course of business to ensure completion of the infrastructure of our projects.  At June 30, 2016, we had approximately $840.6 million in surety bonds outstanding, with respect to which we had an estimated $392.1 million remaining in cost to complete.

 

d.  Mortgage Loans and Commitments

 

We commit to making mortgage loans to our homebuyers through our mortgage financing subsidiary, CalAtlantic Mortgage.  CalAtlantic Mortgage sells substantially all of the loans it originates in the secondary mortgage market and finances these loans under its mortgage credit facilities for a short period of time (typically for 30 to 45 days), as investors complete their administrative review of applicable loan documents.  Mortgage loans in process for which interest rates were committed to borrowers totaled approximately $278.9 million at June 30, 2016 and carried a weighted average interest rate of approximately 4.1%.  Interest rate risks related to these obligations are mitigated by CalAtlantic Mortgage through the preselling of loans to investors or through its interest rate hedging program.  As of June 30, 2016, CalAtlantic Mortgage had approximately $185.5 million in closed mortgage loans held for sale and $23.4 million of mortgage loans that we were committed to sell to investors subject to our funding of the loans and the investors' completion of their administrative review of the applicable loan documents.  In addition, as of June 30, 2016, CalAtlantic Mortgage had approximately $255.5 million of mortgage loans in process that were or are expected to be originated on a non-presold basis, substantially all of which were hedged by forward sale commitments of mortgage-backed securities prior to entering into loan sale transactions with third party investors.

Substantially all of the loans originated by CalAtlantic Mortgage are sold with servicing rights released on a non-recourse basis.  These sales are generally subject to CalAtlantic Mortgage's obligation to repay its gain on sale if the loan is prepaid by the borrower within a certain time period following such sale, or to repurchase the loan if, among other things, the purchaser's underwriting guidelines are not met, or there is fraud in connection with the loan.  During the six months ended June 30, 2016 and 2015, CalAtlantic Mortgage recorded loan loss expense related to indemnification and repurchase allowances of $0.1 million and $0.1 million, respectively. As of June 30, 2016, CalAtlantic Mortgage had indemnity and repurchase allowances related to loans sold of approximately $3.7 million.  In addition, during the second quarter of 2016 and 2015, CalAtlantic Mortgage made make-whole payments of $0.1 million and $0.1 million, respectively.

e.  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.  Our total insurance and litigation accruals as of June 30, 2016 and December 31, 2015 were $125.4 million and $125.3 million, respectively, which are included in accrued liabilities in the accompanying condensed consolidated balance sheets.  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 materially from our currently estimated amounts.

We account for income taxes in accordance with ASC Topic 740, Income Taxes ("ASC 740").  ASC 740 requires an asset and 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.  Changes to enacted tax rates could materially impact the recorded amount of our deferred tax asset.

 

Each quarter we assess our deferred tax asset to determine whether all or any portion of the asset is more likely than not unrealizable under ASC 740.  We are required to establish a valuation allowance for any portion of the asset we conclude is more likely than not to be unrealizable.  Our assessment considers, among other things, the nature, frequency and severity of our prior and cumulative losses, forecasts of our future taxable income, the duration of statutory carryforward periods, our utilization experience with operating loss and tax credit carryforwards, and tax planning alternatives.

 

Our 2016 second quarter provision for income taxes of $66.9 million primarily related to our $179.6 million of pretax income.  As of June 30, 2016, we had a $338.9 million deferred tax asset which was partially offset by a valuation allowance of $1.4 million related to state net operating loss carryforwards that are limited by shorter carryforward periods.  As of such date, $138.6 million of our deferred tax asset related to net operating loss carryforwards ($106.3 million of federal and state net operating loss carryforwards that were subject to the Internal Revenue Code Section 382 ("Section 382") gross annual limitation of $15.6 million for both federal and state purposes, and $32.3 million of state net operating loss carryforwards that were not subject to such limitation).  The remaining deferred tax asset balance of $200.3 million represented deductible timing differences, primarily related to inventory impairments and financial accruals, which have no expiration date.   As of June 30, 2016 and December 31, 2015, our liability for unrecognized tax benefits was $11.7 million and $10.6 million, respectively, which is included in accrued liabilities in the accompanying condensed consolidated balance sheets. In addition, as of June 30, 2016, we remained subject to examination by various tax jurisdictions for the tax years ended December 31, 2011 through 2015.

The following are supplemental disclosures to the condensed consolidated statements of cash flows:

 

Certain of our 100% owned direct and indirect subsidiaries guarantee our outstanding senior notes payable (please see Note 15 "Senior Notes Payable").  Presented below are the condensed consolidated financial statements for our guarantor subsidiaries and non-guarantor subsidiaries.

CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS

 

 

CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS