PHM 09/30/2013 10-Q

______________________________________________________________________________________________________

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549

FORM 10-Q

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2013


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

Commission File Number 1-9804 

PULTEGROUP, INC.
(Exact name of registrant as specified in its charter) 
MICHIGAN
 
38-2766606
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)

100 Bloomfield Hills Parkway, Suite 300
Bloomfield Hills, Michigan 48304
(Address of principal executive offices) (Zip Code)

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

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

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

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

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

Number of shares of common stock outstanding as of October 18, 2013: 383,057,410

______________________________________________________________________________________________________


1

PULTEGROUP, INC.
INDEX

 
 
Page
No.
PART I
 
 
 
 
Item 1
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2
 
 
 
Item 3
 
 
 
Item 4
 
 
 
PART II
 
 
 
Item 2
 
 
 
Item 6
 
 
 
 
 


2

PART I. FINANCIAL INFORMATION

Item 1.      Financial Statements

PULTEGROUP, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
($000’s omitted)
 
 
September 30,
2013
 
December 31,
2012
 
(Unaudited)
 
(Note)
ASSETS
 
 
 
 
 
 
 
Cash and equivalents
$
1,349,994

 
$
1,404,760

Restricted cash
69,421

 
71,950

House and land inventory
4,150,964

 
4,214,046

Land held for sale
65,100

 
91,104

Land, not owned, under option agreements
27,612

 
31,066

Residential mortgage loans available-for-sale
296,922

 
318,931

Investments in unconsolidated entities
45,006

 
45,629

Other assets
440,524

 
407,675

Intangible assets
139,423

 
149,248

Deferred tax assets, net
2,108,756

 
—

 
$
8,693,722

 
$
6,734,409

 
 
 
 
LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
 
 
 
 
Liabilities:
 
 
 
Accounts payable, including book overdrafts of $37,495 and $42,053
     in 2013 and 2012, respectively
$
214,098

 
$
178,274

Customer deposits
173,665

 
101,183

Accrued and other liabilities
1,445,649

 
1,418,063

Income tax liabilities
196,870

 
198,865

Financial Services debt
115,098

 
138,795

Senior notes
2,056,657

 
2,509,613

 
4,202,037

 
4,544,793

 
 
 
 
Shareholders' equity
4,491,685

 
2,189,616

 
 
 
 
 
$
8,693,722

 
$
6,734,409


Note: The Condensed Consolidated Balance Sheet at December 31, 2012 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements.


See accompanying Notes to Condensed Consolidated Financial Statements.


3

PULTEGROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(000’s omitted, except per share data)
(Unaudited)
 
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2013
 
2012
 
2013
 
2012
Revenues:
 
 
 
 
 
 
 
Homebuilding
 
 
 
 
 
 
 
Home sale revenues
$
1,491,959

 
$
1,232,704

 
$
3,811,386

 
$
3,070,895

Land sale revenues
55,783

 
22,623

 
102,299

 
69,770

 
1,547,742

 
1,255,327

 
3,913,685

 
3,140,665

Financial Services
34,336

 
47,264

 
110,571

 
112,367

Total revenues
1,582,078

 
1,302,591

 
4,024,256

 
3,253,032

 
 
 
 
 
 
 
 
Homebuilding Cost of Revenues:
 
 
 
 
 
 
 
Home sale cost of revenues
1,180,137

 
1,023,704

 
3,072,425

 
2,605,249

Land sale cost of revenues
49,933

 
21,061

 
92,661

 
62,069

 
1,230,070

 
1,044,765

 
3,165,086

 
2,667,318

Financial Services expenses
23,244

 
20,578

 
68,867

 
62,914

Selling, general and administrative expenses
138,637

 
125,191

 
418,794

 
372,691

Other expense (income), net
17,055

 
7,453

 
79,166

 
24,570

Interest income
(1,036
)
 
(1,219
)
 
(3,321
)
 
(3,582
)
Interest expense
171

 
201

 
544

 
616

Equity in (earnings) loss of unconsolidated entities
(785
)
 
(284
)
 
(282
)
 
(3,836
)
Income before income taxes
174,722

 
105,906

 
295,402

 
132,341

Income tax expense (benefit)
(2,107,162
)
 
(10,727
)
 
(2,104,661
)
 
(15,062
)
Net income
$
2,281,884

 
$
116,633

 
$
2,400,063

 
$
147,403

 
 
 
 
 
 
 
 
Per share:
 
 
 
 
 
 
 
Basic earnings
$
5.92

 
$
0.31

 
$
6.20

 
$
0.39

Diluted earnings
$
5.87

 
$
0.30

 
$
6.14

 
$
0.38

Cash dividends declared
$
0.10

 
$
—

 
$
0.10

 
$
—




See accompanying Notes to Condensed Consolidated Financial Statements.


4

PULTEGROUP, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(000’s omitted)
(Unaudited)

 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2013
 
2012
 
2013
 
2012
Net income
$
2,281,884

 
$
116,633

 
$
2,400,063

 
$
147,403

 
 
 
 
 
 
 
 
Other comprehensive income, net of tax:
 
 
 
 
 
 
 
Change in fair value of derivatives
77

 
58

 
273

 
173

Other comprehensive income
77

 
58

 
273

 
173

 
 
 
 
 
 
 
 
Comprehensive income
$
2,281,961

 
$
116,691

 
$
2,400,336

 
$
147,576





See accompanying Notes to Condensed Consolidated Financial Statements.


5

PULTEGROUP, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
(000's omitted, except per share data)
(Unaudited)
 
Common Stock
 
Additional
Paid-in
Capital
 
Accumulated
Other
Comprehensive
Income
(Loss)
 
Retained
Earnings
(Accumulated
Deficit)
 
Total
Shares
 
$
 
Shareholders' Equity, January 1, 2013
386,608

 
$
3,866

 
$
3,030,889

 
$
(992
)
 
$
(844,147
)
 
$
2,189,616

Stock option exercises
1,359

 
14

 
18,535

 
—

 
—

 
18,549

Stock awards, net of cancellations
700

 
7

 
(7
)
 
—

 
—

 
—

Dividends declared
—

 
—

 
—

 
—

 
(38,462
)
 
(38,462
)
Stock repurchases
(5,609
)
 
(56
)
 
(3,063
)
 
—

 
(86,821
)
 
(89,940
)
Stock-based compensation
—

 
—

 
11,586

 
—

 
—

 
11,586

Net income
—

 
—

 
—

 
—

 
2,400,063

 
2,400,063

Other comprehensive income
—

 
—

 
—

 
273

 
—

 
273

Shareholders' Equity, September 30, 2013
383,058

 
$
3,831

 
$
3,057,940

 
$
(719
)
 
$
1,430,633

 
$
4,491,685

 
 
 
 
 
 
 
 
 
 
 
 
Shareholders' Equity, January 1, 2012
382,608

 
$
3,826

 
$
2,986,240

 
$
(1,306
)
 
$
(1,050,145
)
 
$
1,938,615

Stock option exercises
2,403

 
24

 
27,408

 
—

 
—

 
27,432

Stock awards, net of cancellations
1,316

 
13

 
(13
)
 
—

 
—

 
—

Stock repurchases
(104
)
 
(1
)
 
(813
)
 
—

 
(147
)
 
(961
)
Stock-based compensation
—

 
—

 
9,384

 
—

 
—

 
9,384

Net income
—

 
—

 
—

 
—

 
147,403

 
147,403

Other comprehensive income
—

 
—

 
—

 
173

 
—

 
173

Shareholders' Equity, September 30, 2012
386,223

 
$
3,862

 
$
3,022,206

 
$
(1,133
)
 
$
(902,889
)
 
$
2,122,046



See accompanying Notes to Condensed Consolidated Financial Statements.

6

PULTEGROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
($000’s omitted)
(Unaudited)
 
Nine Months Ended
 
September 30,
 
2013
 
2012
Cash flows from operating activities:
 
 
 
Net income
$
2,400,063

 
$
147,403

Adjustments to reconcile net income to net cash flows provided by (used in)
      operating activities:
 
 
 
Deferred income taxes
(2,108,756
)
 
—

Write-down of land inventory and deposits and pre-acquisition costs
6,371

 
12,623

Depreciation and amortization
23,134

 
22,278

Stock-based compensation expense
21,570

 
14,368

Equity in (earnings) loss of unconsolidated entities
(282
)
 
(3,836
)
Distributions of earnings from unconsolidated entities
1,693

 
7,223

Loss on debt retirements
26,930

 
—

Other non-cash, net
5,943

 
5,254

Increase (decrease) in cash due to:
 
 
 
Restricted cash
1,654

 
(966
)
Inventories
89,040

 
160,973

Residential mortgage loans available-for-sale
21,967

 
(5,275
)
Other assets
(29,989
)
 
(1,612
)
Accounts payable, accrued and other liabilities
97,607

 
63,832

Income tax liabilities
(1,995
)
 
(1,033
)
Net cash provided by (used in) operating activities
554,950

 
421,232

Cash flows from investing activities:
 
 
 
Distributions from unconsolidated entities
200

 
2,696

Investments in unconsolidated entities
(1,057
)
 
(1,266
)
Net change in loans held for investment
236

 
736

Change in restricted cash related to letters of credit
875

 
26,096

Proceeds from the sale of property and equipment
9

 
4,705

Capital expenditures
(18,354
)
 
(10,597
)
Net cash provided by (used in) investing activities
(18,091
)
 
22,370

Cash flows from financing activities:
 
 
 
Financial Services borrowings (repayments)
(23,697
)
 
103,000

Other borrowings (repayments)
(477,220
)
 
(92,493
)
Stock option exercises
18,549

 
27,432

Stock repurchases
(89,940
)
 
(961
)
Dividends paid
(19,317
)
 
—

Net cash provided by (used in) financing activities
(591,625
)
 
36,978

Net increase (decrease) in cash and equivalents
(54,766
)
 
480,580

Cash and equivalents at beginning of period
1,404,760

 
1,083,071

Cash and equivalents at end of period
$
1,349,994

 
$
1,563,651

 
 
 
 
Supplemental Cash Flow Information:
 
 
 
Interest paid (capitalized), net
$
(18,304
)
 
$
(28,072
)
Income taxes paid (refunded), net
$
(792
)
 
$
(12,901
)
See accompanying Notes to Condensed Consolidated Financial Statements.

7
PULTEGROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)




1. Summary of significant accounting policies

Basis of presentation

PulteGroup, Inc. is one of the largest homebuilders in the United States. Our common stock trades on the New York Stock Exchange under the ticker symbol “PHM”. Unless the context otherwise requires, the terms "PulteGroup", the "Company", "we", "us", and "our" used herein refer to PulteGroup, Inc. and its subsidiaries. While our subsidiaries engage primarily in the homebuilding business, we also have mortgage banking operations, conducted principally through Pulte Mortgage LLC (“Pulte Mortgage”), and title operations.

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with United States generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by United States generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal, recurring adjustments) considered necessary for a fair presentation have been included. Operating results for the interim periods presented are not necessarily indicative of the results that may be expected for the full year. These financial statements should be read in conjunction with our consolidated financial statements and footnotes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2012.

Use of estimates

The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.

Subsequent events

We evaluated subsequent events up until the time the financial statements were filed with the Securities and Exchange Commission ("SEC").

Cash and equivalents

Cash and equivalents include institutional money market investments and time deposits with a maturity of three months or less when acquired. Cash and equivalents at September 30, 2013 and December 31, 2012 also included $13.6 million and $8.1 million, respectively, of cash from home closings held in escrow for our benefit, typically for less than five days, which are considered deposits in-transit.

Restricted cash

We maintain certain cash balances that are restricted as to their use. Restricted cash consists primarily of deposits maintained with financial institutions under cash-collateralized letter of credit agreements (see Note 9). The remaining balances relate to certain other accounts with restrictions, including customer deposits on home sales that are temporarily restricted by regulatory requirements until title transfers to the homebuyer.




8
PULTEGROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


Other expense (income), net

Other expense (income), net consists of the following ($000’s omitted): 

 
Three Months Ended
 
Nine Months Ended
September 30,
 
September 30,
2013
 
2012
 
2013
 
2012
Write-off of deposits and pre-acquisition costs
$
811

 
$
893

 
$
1,402

 
$
1,798

Loss on debt retirements (Note 9)
3,858

 
—

 
26,930

 
—

Lease exit and related costs (a)
378

 
152

 
1,146

 
6,312

Amortization of intangible assets
3,275

 
3,275

 
9,825

 
9,825

Miscellaneous expense (income), net (b)
8,733

 
3,133

 
39,863

 
6,635

 
$
17,055

 
$
7,453

 
$
79,166

 
$
24,570


(a)
Excludes $2.5 million of lease exit costs classified within Financial Services expense during the nine months ended September 30, 2012. There were no such costs during the three and nine months ended September 30, 2013 or the three months ended September 30, 2012.
(b)
Includes charges of $8.0 million and $38.0 million during the three and nine months ended September 30, 2013, respectively, resulting from a contractual dispute related to a previously completed luxury community (see Note 10).

Notes receivable

In certain instances, we may accept consideration for land sales or other transactions in the form of a note receivable. Such receivables are reported net of allowance for credit losses within other assets. The following represents our notes receivable and related allowance for credit losses ($000’s omitted): 
 
September 30,
2013
 
December 31, 2012
Notes receivable, gross
$
59,683

 
$
57,841

Allowance for credit losses
(27,048
)
 
(26,865
)
Notes receivable, net
$
32,635

 
$
30,976


We also record receivables from various parties in the normal course of business, including amounts due from municipalities, insurance carriers, and vendors. Such receivables are generally reported within other assets. See Residential mortgage loans available-for-sale in Note 1 for a discussion of receivables related to our mortgage operations.

Earnings per share

Basic earnings per share is computed by dividing income (loss) available to common shareholders (the “Numerator”) by the weighted-average number of common shares, adjusted for unvested shares of restricted stock (the “Denominator”) for the period. Computing diluted earnings per share is similar to computing basic earnings per share, except that the Denominator is increased to include the dilutive effects of stock options, non-vested restricted stock, and other potentially dilutive instruments. Any stock options that have an exercise price greater than the average market price are considered to be anti-dilutive and are excluded from the diluted earnings per share calculation. Our earnings per share excludes 10.3 million and 10.5 million stock options and other potentially dilutive instruments for the three and nine months ended September 30, 2013, respectively, and 12.0 million and 18.8 million stock options and other potentially dilutive instruments for the three and nine months ended September 30, 2012, respectively.


9
PULTEGROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


In accordance with ASC 260 "Earnings Per Share" ("ASC 260"), the two-class method determines earnings per share for each class of common stock and participating securities according to an earnings allocation formula that adjusts the Numerator for dividends or dividend equivalents and 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. The Company's outstanding restricted stock awards and deferred shares are considered participating securities. The following table presents the earnings per share of common stock ($000's omitted, except per share data):
 
Three Months Ended
 
Nine Months Ended
September 30,
 
September 30,
2013
 
2012
 
2013
 
2012
Numerator:
 
 
 
 
 
 
 
Net income
$
2,281,884

 
$
116,633

 
$
2,400,063

 
$
147,403

Less: earnings distributed to participating securities
(273
)
 
—

 
(273
)
 
—

Less: undistributed earnings allocated to participating securities
(15,884
)
 
—

 
(17,526
)
 
—

Numerator for basic earnings per share
$
2,265,727

 
$
116,633

 
$
2,382,264

 
$
147,403

Add back: undistributed earnings allocated to participating securities
15,884

 
—

 
17,526

 
—

Less: undistributed earnings reallocated to participating securities
(15,753
)
 
—

 
(17,358
)
 
—

Numerator for diluted earnings per share
$
2,265,858

 
$
116,633

 
$
2,382,432

 
$
147,403

 
 
 
 
 
 
 
 
Denominator:
 
 
 
 
 
 
 
Basic shares outstanding
382,883

 
381,355

 
384,159

 
380,839

Effect of dilutive securities
3,220

 
3,215

 
3,745

 
2,036

Diluted shares outstanding
386,103

 
384,570

 
387,904

 
382,875

 
 
 
 
 
 
 
 
Earnings per share:
 
 
 
 
 
 
 
Basic
$
5.92

 
$
0.31

 
$
6.20

 
$
0.39

Diluted
$
5.87

 
$
0.30

 
$
6.14

 
$
0.38


Land option agreements

In the ordinary course of business, we enter into land option agreements in order to procure land for the construction of homes in the future. Pursuant to these land option agreements, we generally provide a deposit to the seller as consideration for the right to purchase land at different times in the future, usually at predetermined prices. Such contracts enable us to defer acquiring portions of properties owned by third parties or unconsolidated entities until we have determined whether and when to exercise our option, which reduces our financial risks associated with long-term land holdings. Option deposits and pre-acquisition costs (such as environmental testing, surveys, engineering, and entitlement costs) are capitalized if the costs are directly identifiable with the land under option, the costs would be capitalized if we owned the land, and acquisition of the property is probable. Such costs are reflected in other assets and are reclassified to inventory upon taking title to the land. We write off deposits and pre-acquisition costs when it becomes probable that we will not go forward with the project or recover the capitalized costs. Such decisions take into consideration changes in local market conditions, the timing of required land purchases, the availability and best use of necessary incremental capital, and other factors. We record any such write-offs of deposits and pre-acquisition costs within other expense (income), net. See Note 3.

If the entity holding the land under option is a variable interest entity (“VIE”), our deposit represents a variable interest in that entity. If we are determined to be the primary beneficiary of the VIE, we are required to consolidate the VIE. Certain of our land option agreements are with entities considered VIEs. In evaluating whether we are required to consolidate a VIE, we take into consideration that the VIE is generally protected from the first dollar of loss under our land option agreement due to our deposit. Likewise, the VIE's gains are generally capped based on the purchase price within the

10
PULTEGROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


land option agreement. However, we generally have little control or influence over the operations of these VIEs due to our lack of an equity interest in them. Additionally, creditors of the VIE have no recourse against us, and we do not provide financial or other support to these VIEs other than as stipulated in the land option agreements. Our maximum exposure to loss related to these VIEs is generally limited to our deposits and pre-acquisition costs under the applicable land option agreements. Historically, cancellations of land option agreements have resulted in write-offs of the related deposits and pre-acquisition costs but have not exposed us to the overall risks or losses of the applicable VIEs.

Separately, certain land option agreements represent financing arrangements even though we generally have no obligation to pay these future amounts. As a result, we recorded $27.6 million and $31.1 million at September 30, 2013 and December 31, 2012, respectively, to land, not owned, under option agreements with a corresponding increase to accrued and other liabilities. Such amounts represent the remaining purchase price under the land option agreements, some of which are with VIEs, in the event we exercise the purchase rights under the agreements.

The following provides a summary of our interests in land option agreements as of September 30, 2013 and December 31, 2012 ($000’s omitted): 
 
September 30, 2013
 
December 31, 2012
 
Deposits and
Pre-acquisition
Costs
 
Remaining Purchase
Price
 
Land, Not
Owned,
Under
Option
Agreements
 
Deposits and
Pre-acquisition
Costs
 
Remaining Purchase
Price
 
Land, Not
Owned,
Under
Option
Agreements
Consolidated VIEs
$
6,705

 
$
10,488

 
$
12,107

 
$
5,216

 
$
8,590

 
$
8,590

Unconsolidated VIEs
32,678

 
683,158

 
—

 
24,078

 
360,495

 
—

Other land option
    agreements
48,561

 
707,547

 
15,505

 
40,822

 
554,307

 
22,476

 
$
87,944

 
$
1,401,193

 
$
27,612

  
$
70,116

 
$
923,392

 
$
31,066


Residential mortgage loans available-for-sale

Substantially all of the loans originated by us are sold in the secondary mortgage market within a short period of time after origination, generally within 30 days. In accordance with ASC 825, “Financial Instruments” (“ASC 825”), we use the fair value option to record residential mortgage loans available-for-sale. Election of the fair value option for these loans allows a better offset of the changes in fair values of the loans and the derivative instruments used to economically hedge them without having to apply complex hedge accounting provisions. We do not designate any derivative instruments as hedges or apply the hedge accounting provisions of ASC 815, “Derivatives and Hedging.”

Expected gains and losses from the sale of residential mortgage loans and their related servicing rights are included in the measurement of written loan commitments that are accounted for at fair value through Financial Services revenues at the time of commitment.  Subsequent changes in the fair value of these loans are reflected in Financial Services revenues as they occur. At September 30, 2013 and December 31, 2012, residential mortgage loans available-for-sale had an aggregate fair value of $296.9 million and $318.9 million, respectively, and an aggregate outstanding principal balance of $285.9 million and $305.3 million, respectively. The net gain (loss) resulting from changes in fair value of these loans totaled $4.4 million and $0.9 million for the three months ended September 30, 2013 and 2012, respectively, and $2.6 million and $0.6 million for the nine months ended September 30, 2013 and 2012. These changes in fair value were substantially offset by changes in fair value of the corresponding hedging instruments. Net gains from the sale of mortgages were $18.1 million and $33.9 million for the three months ended September 30, 2013 and 2012, respectively, and $66.4 million and $76.9 million for the nine months ended September 30, 2013 and 2012, respectively, and have been included in Financial Services revenues.

Derivative instruments and hedging activities

We are exposed to market risks from commitments to lend, movements in interest rates, and canceled or modified commitments to lend. A commitment to lend at a specific interest rate (an interest rate lock commitment) is a derivative financial instrument (interest rate is locked to the borrower). In order to reduce these risks, we use other derivative financial instruments, principally cash forward placement contracts on mortgage-backed securities and whole loan investor

11
PULTEGROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


commitments, to economically hedge the interest rate lock commitment. We enter into these derivative financial instruments based upon our portfolio of interest rate lock commitments and closed loans. We do not use any derivative financial instruments for trading purposes.

At September 30, 2013 and December 31, 2012, we had aggregate interest rate lock commitments of $317.7 million and $161.6 million, respectively, which were originated at interest rates prevailing at the date of commitment. Since we can terminate a loan commitment if the borrower does not comply with the terms of the contract, and some loan commitments may expire without being drawn upon, these commitments do not necessarily represent future cash requirements. We evaluate the creditworthiness of these transactions through our normal credit policies.

Forward contracts on mortgage-backed securities are commitments to either purchase or sell a specified financial instrument at a specified future date for a specified price that may be settled in cash, by offsetting the position, or through the delivery of the financial instrument. Forward contracts on mortgage-backed securities are the predominant derivative financial instruments we use to minimize market risk during the period from the time we extend an interest rate lock to a loan applicant until the time the loan is sold to an investor. We also use whole loan investor commitments, which are obligations of the investor to buy loans at a specified price within a specified time period. At September 30, 2013 and December 31, 2012, we had unexpired forward contracts of $519.6 million and $428.0 million, respectively, and whole loan investor commitments of $30.2 million and $4.7 million, respectively. Changes in the fair value of interest rate lock commitments and other derivative financial instruments are recognized in Financial Services revenues, and the fair values are reflected in other assets or other liabilities, as applicable.

There are no credit-risk-related contingent features within our derivative agreements, and counterparty risk is considered minimal. Gains and losses on interest rate lock commitments are substantially offset by corresponding gains or losses on forward contracts on mortgage-backed securities and whole loan investor commitments. We are generally not exposed to variability in cash flows of derivative instruments for more than approximately 75 days.

 The fair values of derivative instruments and their location in the Condensed Consolidated Balance Sheets is summarized below ($000’s omitted):
 
 
September 30, 2013
 
December 31, 2012
 
Other Assets
 
Other Liabilities
 
Other Assets
 
Other Liabilities
Interest rate lock commitments
$
12,239

 
$
117

 
$
6,045

 
$
24

Forward contracts
41

 
8,997

 
245

 
891

Whole loan commitments
78

 
219

 
30

 
85

 
$
12,358

 
$
9,333

 
$
6,320

 
$
1,000


New accounting pronouncements

In December 2011, the FASB issued ASU 2011-11, “Disclosures about Offsetting Assets and Liabilities" ("ASU 2011-11"), which requires entities to disclose information about offsetting and related arrangements of financial instruments and derivative instruments. The guidance was effective for our fiscal year beginning January 1, 2013 and was applied retrospectively. The adoption of this guidance, which is related to disclosure only, did not have a material impact on our financial statements.


12
PULTEGROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


2. Corporate office relocation

On May 31, 2013, we announced our plan to relocate our corporate offices to Atlanta, Georgia, from its current location in Bloomfield Hills, Michigan, in 2014. The decision to relocate reflects long-term growth trends for both us and the homebuilding industry and is intended to bring our corporate offices closer to our customers and a larger portion of our investment portfolio. The relocation of operations will occur in phases over time but is expected to be substantially complete no later than early 2015. We expect to incur the following approximate costs in connection with the relocation, the substantial majority of which represent future cash expenditures ($000's omitted):
Employee severance, retention, and relocation costs
$
21,000

to
$
26,000

Asset impairments
355

to
500

Lease termination and other exit costs
27,000

to
32,000


During the three and nine months ended September 30, 2013, we recorded employee severance, retention, and relocation costs of $0.3 million and $13.4 million, respectively, and asset impairments of $0.0 million and $0.4 million, respectively. Severance, retention, and relocation costs are recorded within selling, general, and administrative expense, while lease exit and asset impairments are included in other expense (income), net. We expect to record additional charges of approximately $2.0 million in 2013 related to the relocation with the remaining costs to be recognized primarily in 2014 and early 2015. We will also incur costs at the new location related to the recruitment and onboarding of new employees and certain redundant operating costs. The amount of such costs is not expected to be material.

3. Inventory and land held for sale

Major components of inventory were as follows ($000’s omitted): 
 
September 30,
2013
 
December 31,
2012
Homes under construction
$
1,277,648

 
$
1,116,184

Land under development
2,117,653

 
2,435,378

Raw land
755,663

 
662,484

 
$
4,150,964

 
$
4,214,046


We capitalize interest cost into inventory during the active development and construction of our communities. Each layer of capitalized interest is amortized over a period that approximates the average life of communities under development. Interest expense is recorded based on the timing of home closings. Interest expensed to Homebuilding home sale cost of revenues included capitalized interest related to inventory impairments of $0.8 million and $1.9 million, for the three months ended September 30, 2013 and 2012, respectively, and $2.7 million and $4.9 million for the nine months ended September 30, 2013 and 2012, respectively. In all periods presented, we capitalized all Homebuilding interest costs into inventory because the level of our active inventory exceeded our debt levels.

Information related to interest capitalized into inventory is as follows ($000’s omitted):
 
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2013
 
2012
 
2013
 
2012
Interest in inventory, beginning of period
$
298,575

 
$
358,451

 
$
331,880

 
$
355,068

Interest capitalized
35,962

 
50,730

 
118,527

 
153,369

Interest expensed
(68,013
)
 
(57,155
)
 
(183,883
)
 
(156,411
)
Interest in inventory, end of period
$
266,524

 
$
352,026

 
$
266,524

 
$
352,026

Interest incurred*
$
35,962

 
$
50,730

 
$
118,527

 
$
153,369


*
Homebuilding interest incurred includes interest on senior debt and certain other financing arrangements.


13
PULTEGROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


Land valuation adjustments and write-offs

Impairment of inventory

We record valuation adjustments on land inventory and related communities under development when events and circumstances indicate that they may be impaired and when the cash flows estimated to be generated by those assets are less than their carrying amounts. Such indicators include gross margin or sales paces significantly below expectations, construction costs or land development costs significantly in excess of budgeted amounts, significant delays or changes in the planned development for the community, and other known qualitative factors. For communities that are not yet active, an additional consideration includes an evaluation of the probability, timing, and cost of obtaining necessary approvals from municipalities and any potential concessions that may be necessary in order to obtain such approvals. We also consider potential changes to the product offerings in a community and any alternative strategies for the land, such as the sale of the land either in whole or in parcels. Communities that demonstrate potential impairment indicators are tested for impairment. We compare the expected undiscounted cash flows for these communities to their carrying values. For those communities whose carrying values exceed the expected undiscounted cash flows, we estimate the fair value of the community. Impairment charges are recorded if the fair value of the community's inventory is less than its carrying value.

We determine the fair value of a community's inventory using a combination of market comparable land transactions, where available, and discounted cash flow models. These estimated cash flows are significantly impacted by estimates related to expected average selling prices, expected sales paces, expected land development and construction timelines, and anticipated land development, construction, and overhead costs. The assumptions used in the discounted cash flow models are specific to each community tested for impairment. Due to uncertainties in the estimation process, the significant volatility in demand for new housing, and the long life cycles of many communities, actual results could differ significantly from such estimates. Our determination of fair value also requires discounting the estimated cash flows at a rate commensurate with the inherent risks associated with each of the assets and related estimated cash flow streams. The discount rate used in determining each community's fair value depends on the stage of development of the community and other specific factors that increase or decrease the inherent risks associated with the community's cash flow streams. For example, communities that are entitled and near completion will generally be assigned a lower discount rate than communities that are not entitled and consist of multiple phases spanning several years of development and construction.

During the three and nine months ended September 30, 2013 and 2012, we reviewed each of our land positions for potential impairment. As a result of these reviews, we recorded impairments of $0.8 million and $2.3 million during the three months ended September 30, 2013 and 2012, respectively, and $2.7 million and $9.6 million during the nine months ended September 30, 2013 and 2012, respectively, which are recorded within Homebuilding home sale cost of revenues. Our evaluations for impairments recorded to date were based on our best estimates of the future cash flows for our communities. However, if conditions in the homebuilding industry or our local markets worsen in the future or if our strategy related to certain communities changes, we may be required to evaluate our assets for further impairments or write-downs, which could result in future charges that might be significant.

Net realizable value adjustments – land held for sale

  Land held for sale is valued at the lower of carrying value or fair value less costs to sell. In determining the value of land held for sale, we consider recent offers received, prices for land in recent comparable sales transactions, and other factors. During the three months ended September 30, 2013 and 2012, we recognized net realizable value adjustments related to land held for sale of $0.1 million and $0.2 million, respectively. Such adjustments totaled $2.3 million and $1.3 million during the nine months ended September 30, 2013 and 2012, respectively. We record these net realizable value adjustments within Homebuilding land sale cost of revenues. During 2013, the decrease in the gross land held for sale and net realizable value reserve balances resulted primarily from the sale of land parcels, certain of which were previously impaired. Land held for sale was as follows ($000’s omitted):
 
 
September 30,
2013
 
December 31,
2012
Land held for sale, gross
$
73,698

 
$
135,201

Net realizable value reserves
(8,598
)
 
(44,097
)
Land held for sale, net
$
65,100

 
$
91,104


14
PULTEGROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


Write-off of deposits and pre-acquisition costs

We wrote off deposits and pre-acquisition costs in the amount of $0.8 million and $0.9 million during the three months ended September 30, 2013 and 2012, respectively, and $1.4 million and $1.8 million during the nine months ended September 30, 2013 and 2012, respectively. We record these write-offs of deposits and pre-acquisition costs within other expense (income), net. 

4. Segment information

Our Homebuilding operations are engaged in the acquisition and development of land primarily for residential purposes within the U.S. and the construction of housing on such land. For reporting purposes, our Homebuilding operations are aggregated into six reportable segments:
Northeast:
  
Connecticut, Delaware, Maryland, Massachusetts, New Jersey, New York, Pennsylvania,
Rhode Island, Virginia
Southeast:
  
Georgia, North Carolina, South Carolina, Tennessee
Florida:
 
Florida
Texas:
 
Texas
North:
  
Illinois, Indiana, Michigan, Minnesota, Missouri, Northern California, Ohio, Oregon, Washington
Southwest:
  
Arizona, Colorado, Nevada, New Mexico, Southern California

We also have a reportable segment for our Financial Services operations, which consist principally of mortgage banking and title operations. The Financial Services segment operates generally in the same markets as the Homebuilding segments.

Evaluation of segment performance is generally based on income before income taxes. Each reportable segment generally follows the same accounting policies described in Note 1 - "Summary of Significant Accounting Policies" to the consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2012.

15
PULTEGROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


 
 
Operating Data by Segment
($000’s omitted)
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2013
 
2012
 
2013
 
2012
Revenues:
 
 
 
 
 
 
 
Northeast
$
259,413

 
$
194,732

 
$
555,856

 
$
502,813

Southeast
234,605

 
194,654

 
602,379

 
496,244

Florida
227,614

 
165,621

 
562,890

 
439,665

Texas
217,897

 
179,581

 
621,972

 
471,648

North
343,748

 
277,297

 
826,054

 
666,458

Southwest
264,465

 
243,442

 
744,534

 
563,837

 
1,547,742

 
1,255,327

 
3,913,685

 
3,140,665

Financial Services
34,336

 
47,264

 
110,571

 
112,367

Consolidated
$
1,582,078

 
$
1,302,591

 
$
4,024,256

 
$
3,253,032

 
 
 
 
 
 
 
 
Income (loss) before income taxes:
 
 
 
 
 
 
 
Northeast
$
33,508

 
$
20,303

 
$
62,162

 
$
42,940

Southeast
37,687

 
21,227

 
78,811

 
40,724

Florida
43,834

 
23,723

 
89,711

 
46,530

Texas
32,111

 
18,807

 
79,015

 
34,704

North
48,674

 
26,494

 
95,303

 
38,281

Southwest
49,508

 
27,882

 
119,908

 
41,817

Other homebuilding (a)
(81,728
)
 
(59,257
)
 
(271,308
)
 
(162,230
)
 
163,594

 
79,179

 
253,602

 
82,766

Financial Services (b)
11,128

 
26,727

 
41,800

 
49,575

Consolidated
$
174,722

 
$
105,906

 
$
295,402

 
$
132,341


(a)
Other homebuilding includes the amortization of intangible assets, amortization of capitalized interest, and other items not allocated to the operating segments. Other homebuilding also included for the three and nine months ended September 30, 2013: losses on debt retirements totaling $3.9 million and $26.9 million, respectively; costs associated with the previously announced relocation of our corporate headquarters totaling $0.3 million and $13.8 million, respectively; and charges resulting from a contractual dispute related to a previously completed luxury community totaling $8.0 million and $38.0 million, respectively.
(b)
Financial Services income before income taxes includes interest income of $2.1 million and $1.6 million for the three months ended September 30, 2013 and 2012, respectively, and $5.2 million and $4.1 million for the nine months ended September 30, 2013 and 2012, respectively.

 

16
PULTEGROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


 
Land-Related Charges by Segment
($000's omitted)
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2013
 
2012
 
2013
 
2012
Land and community valuation adjustments:
 
 
 
 
 
 
 
Northeast
$
—

 
$
—

 
$
—

 
$
535

Southeast
—

 
—

 
—

 
—

Florida
—

 
—

 
—

 
—

Texas
—

 
—

 
—

 
—

North
—

 
385

 
—

 
2,373

Southwest
—

 
—

 
—

 
1,810

Other homebuilding (a)
766

 
1,878

 
2,701

 
4,855

 
$
766

 
$
2,263

 
$
2,701

 
$
9,573

Net realizable value adjustments (NRV) - land held
   for sale:
 
 
 
 
 
 
 
Northeast
$
—

 
$
—

 
$
—

 
$
—

Southeast
—

 
69

 
—

 
350

Florida
—

 
11

 
567

 
49

Texas
(6
)
 
154

 
(2
)
 
412

North
172

 
29

 
1,703

 
94

Southwest
(81
)
 
(14
)
 
—

 
347

 
$
85

 
$
249

 
$
2,268

 
$
1,252

Write-off of deposits and pre-acquisition costs:
 
 
 
 
 
 
 
Northeast
$
219

 
$
727

 
$
328

 
$
815

Southeast
56

 
46

 
144

 
589

Florida
126

 
69

 
208

 
80

Texas
6

 
21

 
2

 
70

North
155

 
13

 
337

 
156

Southwest
249

 
17

 
383

 
88

 
$
811

 
$
893

 
$
1,402

 
$
1,798

Total land-related charges
$
1,662

 
$
3,405

 
$
6,371

 
$
12,623


(a)
Represents write-offs of capitalized interest related to land and community valuation adjustments.

17
PULTEGROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


 
Operating Data by Segment
 
($000's omitted)
 
September 30, 2013
 
Homes Under
Construction
 
Land Under
Development
 
Raw Land
 
Total
Inventory
 
Total
Assets
Northeast
$
263,889

 
$
331,779

 
$
117,532

 
$
713,200

 
$
809,063

Southeast
160,916

 
256,949

 
131,724

 
549,589

 
589,929

Florida
161,204

 
293,858

 
91,238

 
546,300

 
629,724

Texas
148,158

 
221,958

 
49,607

 
419,723

 
477,936

North
300,452

 
327,529

 
100,737

 
728,718

 
781,447

Southwest
197,689

 
475,663

 
206,387

 
879,739

 
955,368

Other homebuilding (a)
45,340

 
209,917

 
58,438

 
313,695

 
4,098,818

 
1,277,648

 
2,117,653

 
755,663

 
4,150,964

 
8,342,285

Financial Services
—

 
—

 
—

 
—

 
351,437

 
$
1,277,648

 
$
2,117,653

 
$
755,663

 
$
4,150,964

 
$
8,693,722

 
 
 
 
 
 
 
 
 
 
 
December 31, 2012
 
Homes Under
Construction
 
Land Under
Development
 
Raw Land
 
Total
Inventory
 
Total
Assets
Northeast
$
198,549

 
$
445,436

 
$
109,136

 
$
753,121

 
$
866,024

Southeast
147,227

 
286,210

 
120,193

 
553,630

 
590,650

Florida
130,276

 
310,625

 
100,633

 
541,534

 
620,220

Texas
145,594

 
256,704

 
54,556

 
456,854

 
523,843

North
219,172

 
369,144

 
46,414

 
634,730

 
680,447

Southwest
226,204

 
496,488

 
167,295

 
889,987

 
963,540

Other homebuilding (a)
49,162

 
270,771

 
64,257

 
384,190

 
2,140,739

 
1,116,184

 
2,435,378

 
662,484

 
4,214,046

 
6,385,463

Financial Services
—

 
—

 
—

 
—

 
348,946

 
$
1,116,184

 
$
2,435,378

 
$
662,484

 
$
4,214,046

 
$
6,734,409

 
(a)
Other homebuilding primarily includes cash and equivalents, capitalized interest, net deferred tax assets, intangibles, and other corporate items that are not allocated to the operating segments.
 

18
PULTEGROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


5. Investments in unconsolidated entities

We participate in a number of joint ventures with independent third parties. Many of these joint ventures purchase, develop, and/or sell land and homes. A summary of our joint ventures is presented below ($000’s omitted):
 
 
September 30,
2013
 
December 31,
2012
Investments in joint ventures with debt non-recourse to PulteGroup
$
26,362

 
$
11,155

Investments in other active joint ventures
18,644

 
34,474

Total investments in unconsolidated entities
$
45,006

 
$
45,629

 
 
 
 
Total joint venture debt
$
10,104

 
$
6,915

 
 
 
 
PulteGroup proportionate share of joint venture debt:
 
 
 
Joint venture debt with limited recourse guaranties
$
955

 
$
769

Joint venture debt non-recourse to PulteGroup
2,065

 
826

PulteGroup's total proportionate share of joint venture debt
$
3,020

 
$
1,595


We recognized (income) expense from unconsolidated joint ventures of $(0.8) million and $(0.3) million during the three months ended September 30, 2013 and 2012, respectively, and $(0.3) million and $(3.8) million during the nine months ended September 30, 2013 and 2012, respectively. During the nine months ended September 30, 2013 and 2012 we made capital contributions of $1.1 million and $1.3 million, respectively, and received capital and earnings distributions of $1.9 million and $9.9 million, respectively.

The timing of cash obligations under the joint venture and any related financing agreements varies by agreement. If additional capital contributions are required and approved, we would need to contribute our pro rata portion of those capital needs in order to not dilute our ownership in the joint ventures. While future capital contributions may be required, we believe the total amount of such contributions will be limited. Our maximum financial loss exposure related to joint ventures is unlikely to exceed the combined investment and limited recourse guaranty totals.

6. Shareholders’ equity

We reinstated our quarterly cash dividend in July 2013. During the three months ended September 30, 2013, we declared two cash dividends of $0.05 per common share; the first paid in August 2013, the second in October 2013.

In July 2013, we increased our common share repurchase authorization to $352.3 million of common shares. During the three months ended September 30, 2013, we repurchased 5.3 million shares under the repurchase authorization for a total of $83.0 million. Such repurchases are reflected as a reduction of common stock and retained earnings. At September 30, 2013, we had remaining authorization to repurchase $269.3 million of common shares.

Under our stock-based compensation plans, we accept shares as payment under certain conditions related to stock option exercises and vesting of restricted stock, generally related to the payment of minimum tax obligations. During the nine months ended September 30, 2013 and 2012, employees surrendered shares valued at $6.9 million and $1.0 million, respectively, under these plans. Such share transactions are excluded from the above noted stock repurchase authorization.


19
PULTEGROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


7. Income taxes

Our effective tax rate is affected by a number of factors, the most significant of which are the valuation allowance related to our deferred tax assets and changes in our unrecognized tax benefits. Due to the effects of these factors, our effective tax rates in 2013 and 2012 are not correlated to the amount of our income or loss before income taxes.
From 2007 to 2011, we generated significant deferred tax assets primarily from asset impairments combined with reduced operational profitability. At September 30, 2013 and December 31, 2012, we had deferred tax assets of $2.3 billion and $2.5 billion, respectively. We evaluate our deferred tax assets each period to determine if a valuation allowance is required based on whether it is "more likely than not" that some portion of the deferred tax assets would not be realized. The ultimate realization of these deferred tax assets is dependent upon the generation of sufficient taxable income during future periods.  We conduct our evaluation by considering all available positive and negative evidence. This evaluation considers, among other factors, historical operating results, forecasts of future profitability, the duration of statutory carryforward periods, and the outlooks for the U.S. housing industry and broader economy. Based on our evaluation through June 30, 2013, we fully reserved our net deferred tax assets due to the uncertainty of their realization. One of the primary pieces of negative evidence we considered was the significant losses we incurred in recent years, including being in a three-year cumulative pre-tax loss position through June 30, 2013.
Consistent with the above process, we evaluated the need for a valuation allowance against our deferred tax assets at September 30, 2013, and determined that the valuation allowance against substantially all of our federal deferred tax assets and a significant portion of our state deferred tax assets was no longer required. Accordingly, we reversed $2.1 billion of valuation allowance in the quarter ended September 30, 2013. This reversal is reflected in our income tax expense (benefit) in the accompanying consolidated statements of operations. When a change in valuation allowance is recognized in an interim period, a portion of the valuation allowance to be reversed must be allocated to the remaining interim periods. Accordingly, a portion of the remaining valuation allowance of $231.0 million at September 30, 2013, will reverse in the fourth quarter of 2013. The other components of the remaining valuation allowance relate primarily to state net operating losses that have not met the "more likely than not" realization threshold.
We conducted our evaluation by considering all available positive and negative evidence. The principal positive evidence that led to the reversal of the valuation allowance included: (1) our emergence from a three-year cumulative loss in 2013; (2) the significant positive income we generated during 2012 and 2013, including six consecutive quarters of pretax income; (3) continued improvements in 2013 over recent years in other key operating metrics, including revenues, gross margin, overhead leverage, and backlog; (4) our forecasted future profitability; (5) improvement in our financial position; and (6) significant evidence that conditions in the U.S. housing industry are more favorable than in recent years and our belief that conditions will continue to be favorable over the long-term. Even if industry conditions weaken from current levels, we believe we will be able to adjust our operations to sustain long-term profitability.
The accounting for deferred taxes is based upon an estimate of future results.  Differences between our estimated and actual results could have a material impact on our consolidated results of operations or financial position and our ability to fully realize our deferred tax assets. Changes in existing tax laws could also affect actual tax results and the realization of deferred tax assets over time. 
As a result of our merger with Centex in August 2009, our ability to use certain of Centex’s pre-ownership change NOL carryforwards and built-in losses or deductions is limited by Section 382 of the Internal Revenue Code. Our Section 382 limitation is approximately $67.4 million per year for NOLs, losses realized on built-in loss assets that are sold within 60 months of the ownership change (i.e. before August 2014), and certain deductions. We do not believe that the Section 382 limitation will prevent the Company from using Centex’s pre-ownership change federal NOL carryforwards and built-in losses or deductions.
At September 30, 2013, we had $165.9 million of gross unrecognized tax benefits, of which $31.0 million would impact the effective tax rate if recognized. Additionally, we have $32.9 million of related accrued interest and penalties at September 30, 2013. It is reasonably possible within the next twelve months that our gross unrecognized tax benefits may decrease by up to $130.0 million, excluding interest and penalties, primarily due to expirations of certain statutes of limitations and potential settlements. We are currently under examination by the IRS and various state taxing jurisdictions and anticipate finalizing certain of the examinations within the next twelve months. The final outcome of these examinations is not yet determinable. The statute of limitations for our major tax jurisdictions remains open for examination for tax years 2003 to 2013.

20
PULTEGROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


8. Fair value disclosures

ASC 820, “Fair Value Measurements and Disclosures,” provides a framework for measuring fair value in generally accepted accounting principles and establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The fair value hierarchy can be summarized as follows: 
Level 1
  
Fair value determined based on quoted prices in active markets for identical assets or liabilities.
 
 
Level 2
  
Fair value determined using significant observable inputs, generally either quoted prices in active markets for similar assets or liabilities or quoted prices in markets that are not active.
 
 
Level 3
  
Fair value determined using significant unobservable inputs, such as pricing models, discounted cash flows, or similar techniques.

Our assets and liabilities measured or disclosed at fair value are summarized below ($000’s omitted): 

Financial Instrument
 
Fair Value
Hierarchy
 
Fair Value
September 30,
2013
 
December 31,
2012
 
 
 
 
 
 
 
Measured at fair value on a recurring basis:
 
 
 
 
 
 
Residential mortgage loans available-for-sale
 
Level 2
 
$
296,922

 
$
318,931

Interest rate lock commitments
 
Level 2
 
12,122

 
6,021

Forward contracts
 
Level 2
 
(8,956
)
 
(646
)
Whole loan commitments
 
Level 2
 
(141
)
 
(55
)
 
 
 
 
 
 
 
Measured at fair value on a non-recurring basis:
 
 
 
 
 
 
House and land inventory
 
Level 3
 
$
—

 
$
11,243

 
 
 
 
 
 
 
Disclosed at fair value:
 
 
 
 
 
 
Cash and equivalents (including restricted cash)
 
Level 1
 
$
1,419,415

 
$
1,476,710

Financial Services debt
 
Level 2
 
115,098

 
138,795

Senior notes
 
Level 2
 
2,060,018

 
2,663,451


Fair values for agency residential mortgage loans available-for-sale are determined based on quoted market prices for comparable instruments. Fair values for non-agency residential mortgage loans available-for-sale are determined based on purchase commitments from whole loan investors and other relevant market information available to management. Fair values for interest rate lock commitments, including the value of servicing rights, are based on market prices for similar instruments. Forward contracts on mortgage-backed securities are valued based on market prices for similar instruments. Fair values for whole loan investor commitments are based on market prices for similar instruments from the specific whole loan investor.

Certain assets are required to be recorded at fair value on a non-recurring basis when events and circumstances indicate that the carrying value may not be recoverable. The non-recurring fair values included in the table above represent only those assets whose carrying values were adjusted to fair value as of the respective balance sheet dates. See Note 3 for a more detailed discussion of the valuation methods used for inventory.
The carrying amounts of cash and equivalents and Financial Services debt approximate their fair values due to their short-term nature. The fair values of senior notes are based on quoted market prices, when available. If quoted market prices are not available, fair values are based on quoted market prices of similar issues. The carrying value of senior notes was $2.1 billion at September 30, 2013 and $2.5 billion at December 31, 2012.



21
PULTEGROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


9. Debt

Our senior notes are summarized as follows ($000’s omitted):
 
September 30,
2013
 
December 31,
2012
5.25% unsecured senior notes due January 2014 (a)
$
—

 
$
187,970

5.70% unsecured senior notes due May 2014 (a)
—

 
208,274

5.20% unsecured senior notes due February 2015 (a)
95,627

 
95,615

5.25% unsecured senior notes due June 2015 (a)
232,243

 
264,058

6.50% unsecured senior notes due May 2016 (a)
458,975

 
457,154

7.625% unsecured senior notes due October 2017 (b)
122,641

 
149,481

7.875% unsecured senior notes due June 2032 (a)
299,185

 
299,152

6.375% unsecured senior notes due May 2033 (a)
398,550

 
398,492

6.00% unsecured senior notes due February 2035 (a)
299,436

 
299,417

7.375% unsecured senior notes due June 2046 (a)
150,000

 
150,000

Total senior notes – carrying value (c)
$
2,056,657

 
$
2,509,613

Estimated fair value
$
2,060,018

 
$
2,663,451


(a)
Redeemable prior to maturity; guaranteed on a senior basis by certain wholly-owned subsidiaries.
(b)
Not redeemable prior to maturity; guaranteed on a senior basis by certain wholly-owned subsidiaries.
(c)
The recorded carrying value reflects the impact of various discounts and premiums that are amortized to interest cost over the respective terms of the senior notes.

Debt retirement

During the three and nine months ended September 30, 2013, we retired prior to their scheduled maturity dates $27.0 million and $461.4 million of senior notes, respectively. We recorded losses related to these transactions totaling $3.9 million and $26.9 million during the three and nine months ended September 30, 2013, respectively. Losses on these transactions included the write-off of unamortized discounts, premiums, and transaction fees and are reflected in other expense (income), net. During the three and nine months ended September 30, 2012, we retired $96.4 million of senior notes at their scheduled maturity dates.

Letter of credit facilities

We maintain separate cash-collateralized letter of credit agreements with a number of financial institutions. Letters of credit totaling $53.7 million and $54.5 million were outstanding under these agreements at September 30, 2013 and December 31, 2012, respectively. Under these agreements, we are required to maintain deposits with the respective financial institutions in amounts approximating the letters of credit outstanding. Such deposits are included in restricted cash.

We also maintain an unsecured letter of credit facility with a bank that expires in September 2014. This facility permits the issuance of up to $150.0 million of letters of credit for general corporate purposes in support of any wholly-owned subsidiary. Letters of credit totaling $124.4 million and $124.6 million were outstanding under this facility at September 30, 2013 and December 31, 2012, respectively.


22
PULTEGROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


Financial Services

Pulte Mortgage provides mortgage financing for the majority of our home closings utilizing its own funds and funds made available pursuant to credit agreements with third parties or through intercompany borrowings. Pulte Mortgage uses these resources to finance its lending activities until the mortgage loans are sold in the secondary market, which generally occurs within 30 days.

In September 2013, Pulte Mortgage entered into the First Amendment to Master Repurchase Agreement with third party lenders, which extended the term of the Master Repurchase Agreement (the "Repurchase Agreement") through September 2014, modified the pricing applicable under the Repurchase Agreement, and made other adjustments to the credit available under the Repurchase Agreement. The Repurchase Agreement provides for loan purchases of up to $150.0 million, subject to certain sublimits. Borrowings under the Repurchase Agreement are secured by residential mortgage loans available-for-sale. The Repurchase Agreement contains various affirmative and negative covenants applicable to Pulte Mortgage, including quantitative thresholds related to net worth, net income, and liquidity. At September 30, 2013, Pulte Mortgage had $115.1 million outstanding under the Repurchase Agreement.

10. Commitments and contingencies

Loan origination liabilities

Our mortgage operations may be responsible for losses associated with mortgage loans originated and sold to investors in the event of errors or omissions relating to representations and warranties that the loans sold meet certain requirements, including representations as to underwriting standards, the existence of primary mortgage insurance, and the validity of certain borrower representations in connection with the loan. If determined to be at fault, we either repurchase the loans from the investors or reimburse the investors' losses (a “make-whole” payment).

In recent years, we experienced a significant increase in losses related to repurchase requests as a result of the high level of loan defaults and related losses in the mortgage industry and increasing aggressiveness by investors in presenting such claims to us. To date, the significant majority of these losses relates to loans originated in 2006 and 2007, during which period inherently riskier loan products became more common in the mortgage origination market. In 2006 and 2007, we originated $39.5 billion of loans, excluding loans originated by Centex's former subprime loan business sold by Centex in 2006. Because we generally do not retain the servicing rights to the loans we originate, information regarding the current and historical performance, credit quality, and outstanding balances of such loans is limited. Estimating these loan origination liabilities is further complicated by uncertainties surrounding numerous external factors, such as various macroeconomic factors (including unemployment rates and changes in home prices), actions taken by third parties, including the parties servicing the loans, and the U.S. federal government in its dual capacity as regulator of the U.S. mortgage industry and conservator of the government-sponsored enterprises commonly known as Fannie Mae and Freddie Mac, which own or guarantee the majority of mortgage loans in the U.S.

Most requests received to date relate to make-whole payments on loans that have been foreclosed. Requests undergo extensive analysis to confirm the exposure, attempt to cure the identified defect, and, when necessary, determine our liability. We establish liabilities for such anticipated losses based upon, among other things, the level of current unresolved repurchase requests, the volume of estimated probable future repurchase requests, our ability to cure the defects identified in the repurchase requests, and the severity of the estimated loss upon repurchase. Determining these estimates and the resulting liability requires a significant level of management judgment. We are generally able to cure or refute over 60% of the requests received from investors such that we do not believe repurchases or make-whole payments will ultimately be required. For those requests that we believe will result in repurchases or make-whole payments, actual loss severities are expected to approximate 50% of the outstanding principal balance.

Our current estimates assume that such requests will continue through 2014. Given the ongoing volatility in the mortgage industry, our lack of visibility into the current status of the review process of loans by investors, the claim volumes we continue to experience, and uncertainties regarding the ultimate resolution of these claims, actual costs could differ from our current estimates. Changes in these liabilities were as follows ($000's omitted):

23
PULTEGROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2013
 
2012
 
2013
 
2012
Liabilities, beginning of period
$
154,421

 
$
120,711

 
$
164,280

 
$
128,330

Reserves provided
—

 
—

 
—

 
—

Payments
(8,220
)
 
(2,089
)
 
(18,079
)
 
(9,708
)
Liabilities, end of period
$
146,201

 
$
118,622

 
$
146,201

 
$
118,622


We entered into an agreement in conjunction with the wind down of Centex's mortgage operations, which ceased loan origination activities in December 2009, that provides a guaranty for one major investor of loans originated by Centex. This guaranty provides that we will honor the potential repurchase obligations of Centex's mortgage operations related to breaches of representations and warranties in the origination of a certain pool of loans. Other than with respect to this pool of loans, our contractual repurchase obligations are limited to our mortgage subsidiaries, which are included in non-guarantor subsidiaries (see Note 11 for a discussion of non-guarantor subsidiaries).

The mortgage subsidiary of Centex also sold loans to a bank for inclusion in residential mortgage-backed securities (“RMBSs”) issued by the bank. In connection with these sales, Centex's mortgage subsidiary entered into agreements pursuant to which it may be required to indemnify the bank for losses incurred by investors in the RMBSs arising out of material errors or omissions in certain information provided by the mortgage subsidiary relating to the loans and loan origination process. In 2011, the bank notified us that it has been named defendant in two lawsuits alleging various violations of federal and state securities laws asserting that untrue statements of material fact were included in the registration statements used to market the sale of two RMBS transactions which included $162 million of loans originated by Centex's mortgage subsidiary. The plaintiffs seek unspecified compensatory and/or rescissory damages on behalf of persons who purchased the securities. Neither Centex's mortgage subsidiary nor the Company is named as a defendant in these actions. These actions are in their preliminary stage, and we cannot yet quantify Centex's mortgage subsidiary's potential liability as a result of these indemnification obligations. We do not believe, however, that these matters will have a material adverse impact on the results of operations, financial position, or cash flows of the Company. We are aware of six other RMBS transactions with such indemnity provisions that include an aggregate $116 million of loans originated by Centex's mortgage subsidiary, and we are not aware of any current or threatened legal proceedings regarding those transactions.

Letters of credit and surety bonds

In the normal course of business, we post letters of credit and surety bonds pursuant to certain performance-related obligations, as security for certain land option agreements, and under various insurance programs. The majority of these letters of credit and surety bonds are in support of our land development and construction obligations to various municipalities, other government agencies, and utility companies related to the construction of roads, sewers, and other infrastructure. We had outstanding letters of credit and surety bonds totaling $178.1 million and $1.0 billion at September 30, 2013, respectively, and $179.2 million and $1.0 billion at December 31, 2012, respectively. In the event any such letter of credit or surety bonds are called, we would be obligated to reimburse the issuer of the letter of credit or surety bond. We do not believe that a material amount, if any, of the letters of credit or surety bonds will be called. Our surety bonds generally do not have stated expiration dates; rather we are released from the surety bonds as the underlying contractual performance is completed. Because significant construction and development work has been performed related to the applicable projects but has not yet received final acceptance by the respective counterparties, the aggregate amount of surety bonds outstanding is in excess of the projected cost of the remaining work to be performed.

Litigation and regulatory matters

We are involved in various litigation and legal claims in the normal course of our business operations, including actions brought on behalf of various classes of claimants. We are also subject to a variety of local, state, and federal laws and regulations related to land development activities, house construction standards, sales practices, mortgage lending operations, employment practices, and protection of the environment. As a result, we are subject to periodic examination or inquiry by various governmental agencies that administer these laws and regulations.


24
PULTEGROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


We establish liabilities for legal claims and regulatory matters when such matters are both probable of occurring and any potential loss is reasonably estimable. We accrue for such matters based on the facts and circumstances specific to each matter and revise these estimates as the matters evolve. In such cases, there may exist an exposure to loss in excess of any amounts currently accrued. In view of the inherent difficulty of predicting the outcome of these legal and regulatory matters, we generally cannot predict the ultimate resolution of the pending matters, the related timing, or the eventual loss. While the outcome of such contingencies cannot be predicted with certainty, we do not believe that the resolution of such matters will have a material adverse impact on our results of operations, financial position, or cash flows. However, to the extent the liability arising from the ultimate resolution of any matter exceeds the estimates reflected in the recorded reserves relating to such matter, we could incur additional charges that could be significant.

We are engaged in arbitration related to a previously completed luxury community in a market we have since exited. The arbitration relates to a variety of claims involving a contractual dispute with certain homeowners. Based on the various stages of these claims, we anticipate most, if not all, of these claims being resolved during 2013. As the result of various rulings by the arbitrator and ongoing settlement discussions, we recorded charges of $8.0 million and $38.0 million during the three and nine months ended September 30, 2013, respectively. While the ultimate outcome of this matter remains uncertain, we believe that the final resolution will not vary materially from our current estimates.

Allowance for warranties

Home purchasers are provided with a limited warranty against certain building defects, including a one-year comprehensive limited warranty and coverage for certain other aspects of the home’s construction and operating systems for periods of up to 10 years. We estimate the costs to be incurred under these warranties and record liabilities in the amount of such costs at the time product revenue is recognized. Factors that affect our warranty liabilities include the number of homes sold, historical and anticipated rates of warranty claims, and the cost per claim. We periodically assess the adequacy of the warranty liabilities for each geographic market in which we operate and adjust the amounts as necessary. Actual warranty costs in the future could differ from the current estimates. Changes to warranty liabilities were as follows ($000’s omitted):
 
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2013
 
2012
 
2013
 
2012
Warranty liabilities, beginning of period
$
61,914

 
$
64,364

 
$
64,098

 
$
68,025

Reserves provided
15,322

 
12,593

 
36,079

 
32,014

Payments
(10,551
)
 
(10,976
)
 
(32,330
)
 
(34,336
)
Other adjustments
(1,602
)
 
(1,453
)
 
(2,764
)
 
(1,175
)
Warranty liabilities, end of period
$
65,083

 
$
64,528

 
$
65,083

 
$
64,528


Self-insured risks

We maintain, and require our subcontractors to maintain, general liability insurance coverage. We also maintain builders' risk, property, errors and omissions, workers compensation, and other business insurance coverage. These insurance policies protect us against a portion of the risk of loss from claims. However, we retain a significant portion of the overall risk for such claims either through policies issued by our captive insurance subsidiaries or through our own self-insured per occurrence and aggregate retentions, deductibles, and claims in excess of available insurance policy limits.

Our general liability insurance includes coverage for certain construction defects. While construction defect claims can relate to a variety of circumstances, the majority of our claims relate to alleged problems with siding, plumbing, foundations and other concrete work, windows, roofing, and heating, ventilation and air conditioning systems. The availability of general liability insurance for the homebuilding industry and its subcontractors has become increasingly limited, and the insurance policies available require companies to maintain significant per occurrence and aggregate retention levels. In certain instances, we may offer our subcontractors the opportunity to purchase insurance through one of our captive insurance subsidiaries or to participate in a project-specific insurance program provided by the Company. Policies issued by the captive insurance subsidiaries represent self-insurance of these risks by the Company. This self-insured exposure is limited by reinsurance policies that we purchase. General liability coverage for the homebuilding industry is complex, and our coverage varies from policy year to policy year. Our insurance coverage requires a per

25
PULTEGROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


occurrence deductible up to an overall aggregate retention level. Beginning with the first dollar, amounts paid on insured claims satisfy our per occurrence and aggregate retention obligations. Any amounts incurred in excess of the occurrence or aggregate retention levels are covered by insurance up to our purchased coverage levels. Our insurance policies, including the captive insurance subsidiaries' reinsurance policies, are maintained with highly-rated underwriters for whom we believe counterparty default risk is not significant.

At any point in time, we are managing over 1,000 individual claims related to general liability, property, errors and omission, workers compensation, and other business insurance coverage. We reserve for costs associated with such claims (including expected claims management expenses) on an undiscounted basis at the time revenue is recognized for each home closing and evaluate the recorded liabilities based on actuarial analyses of our historical claims. The actuarial analyses calculate estimates of the ultimate net cost of all unpaid losses, including estimates for incurred but not reported losses ("IBNR"). IBNR represents losses related to claims incurred but not yet reported plus development on reported claims. These estimates comprise a significant portion of our liability and are subject to a high degree of uncertainty due to a variety of factors, including changes in claims reporting and resolution patterns, third party recoveries, insurance industry practices, the regulatory environment, and legal precedent. State regulations vary, but construction defect claims are reported and resolved over an extended period often exceeding ten years. In certain instances, we have the ability to recover a portion of our costs under various insurance policies or from subcontractors or other third parties. Estimates of such amounts are recorded when recovery is considered probable.

Our recorded reserves for all such claims totaled $691.6 million at September 30, 2013, the vast majority of which relates to general liability claims. The recorded reserves include loss estimates related to both (i) existing claims and related claim expenses and (ii) IBNR and related claim expenses. Liabilities related to IBNR and related claim expenses represented approximately 77% of the total general liability reserves at September 30, 2013. The actuarial analyses that determine the IBNR portion of reserves consider a variety of factors, including the frequency and severity of losses, which are based on our historical claims experience supplemented by industry data. The actuarial analyses of the reserves also consider historical third party recovery rates and claims management expenses.

Adjustments to reserves are recorded in the period in which the change in estimate occurs. Because the majority of our reserves relates to IBNR, adjustments to reserve amounts for individual existing claims generally do not impact the recorded reserves materially. However, changes in the frequency and timing of reported claims and estimates of specific claim values can impact the underlying inputs and trends utilized in the actuarial analyses, which could have a material impact on the recorded reserves. Because of the inherent uncertainty in estimating future losses related to these claims, actual costs could differ significantly from estimated costs. Costs associated with our insurance programs are classified within selling, general, and administrative expenses. Changes in these liabilities were as follows ($000's omitted):
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2013
 
2012
 
2013
 
2012
Balance, beginning of period
$
708,142

 
$
733,042

 
$
721,284

 
$
739,029

Reserves provided
21,439

 
15,557

 
52,266

 
37,772

Payments
(37,983
)
 
(24,773
)
 
(81,952
)
 
(52,975
)
Balance, end of period
$
691,598

 
$
723,826

 
$
691,598

 
$
723,826


11. Supplemental Guarantor information

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

26
PULTEGROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


 CONDENSED CONSOLIDATING BALANCE SHEET
SEPTEMBER 30, 2013
($000’s omitted)
 
Unconsolidated
 
Eliminating
Entries
 
Consolidated
PulteGroup,
Inc.
 
PulteGroup,
Inc.
 
Guarantor
Subsidiaries
 
Non-Guarantor
Subsidiaries
 
ASSETS
 
 
 
 
 
 
 
 
 
Cash and equivalents
$
187,299

 
$
1,080,993

 
$
81,702

 
$
—

 
$
1,349,994

Restricted cash
53,672

 
4,455

 
11,294

 
—

 
69,421

House and land inventory
—

 
4,150,254

 
710

 
—

 
4,150,964

Land held for sale
—

 
64,066

 
1,034

 
—

 
65,100

Land, not owned, under option
       agreements
—

 
27,612

 
—

 
—

 
27,612

Residential mortgage loans available-
       for-sale
—

 
—

 
296,922

 
—

 
296,922

Investments in unconsolidated entities
66

 
40,983

 
3,957

 
—

 
45,006

Other assets
40,125

 
353,549

 
46,850

 
—

 
440,524

Intangible assets
—

 
139,423

 
—

 
—

 
139,423

Deferred tax assets, net
2,087,306

 
20

 
21,430

 
—

 
2,108,756

Investments in subsidiaries and
       intercompany accounts, net
4,461,536

 
644,702

 
5,035,100

 
(10,141,338
)
 
—

 
$
6,830,004

 
$