PHM 09/30/2014 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, 2014

or

[ ] 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.)

3350 Peachtree Road NE, Suite 150
Atlanta, Georgia 30326
(Address of principal executive offices) (Zip Code)

Registrant’s telephone number, including area code: (404) 978-6400

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 Exchange Act).  
YES [ ]  NO  [X]

Number of shares of common stock outstanding as of October 17, 2014: 370,767,579 ______________________________________________________________________________________________________

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,
2014
 
December 31,
2013
 
(Unaudited)
 
(Note)
ASSETS
 
 
 
 
 
 
 
Cash and equivalents
$
1,221,817

 
$
1,580,329

Restricted cash
25,003

 
72,715

House and land inventory
4,431,801

 
3,978,561

Land held for sale
93,162

 
61,735

Land, not owned, under option agreements
16,817

 
24,024

Residential mortgage loans available-for-sale
236,372

 
287,933

Investments in unconsolidated entities
40,295

 
45,323

Other assets
500,744

 
460,621

Intangible assets
126,340

 
136,148

Deferred tax assets, net
1,922,294

 
2,086,754

 
$
8,614,645

 
$
8,734,143

 
 
 
 
LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
 
 
 
 
Liabilities:
 
 
 
Accounts payable, including book overdrafts of $42,636 and $35,827
     in 2014 and 2013, respectively
$
299,004

 
$
202,736

Customer deposits
192,551

 
134,858

Accrued and other liabilities
1,327,819

 
1,377,750

Income tax liabilities
196,214

 
206,015

Financial Services debt
71,594

 
105,664

Senior notes
1,817,054

 
2,058,168

 
3,904,236

 
4,085,191

 
 
 
 
Shareholders' equity
4,710,409

 
4,648,952

 
 
 
 
 
$
8,614,645

 
$
8,734,143


Note: The Condensed Consolidated Balance Sheet at December 31, 2013 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,
 
2014
 
2013
 
2014
 
2013
Revenues:
 
 
 
 
 
 
 
Homebuilding
 
 
 
 
 
 
 
Home sale revenues
$
1,551,226

 
$
1,491,959

 
$
3,885,703

 
$
3,811,386

Land sale revenues
10,047

 
55,783

 
24,558

 
102,299

 
1,561,273

 
1,547,742

 
3,910,261

 
3,913,685

Financial Services
33,452

 
34,336

 
89,544

 
110,571

Total revenues
1,594,725

 
1,582,078

 
3,999,805

 
4,024,256

 
 
 
 
 
 
 
 
Homebuilding Cost of Revenues:
 
 
 
 
 
 
 
Home sale cost of revenues
1,195,369

 
1,180,137

 
2,976,665

 
3,072,425

Land sale cost of revenues
3,539

 
49,933

 
15,382

 
92,661

 
1,198,908

 
1,230,070

 
2,992,047

 
3,165,086

Financial Services expenses
22,623

 
23,244

 
48,058

 
68,867

Selling, general and administrative expenses
147,136

 
138,637

 
521,791

 
418,794

Other expense, net
2,406

 
17,055

 
25,561

 
79,166

Interest income
(1,205
)
 
(1,036
)
 
(3,431
)
 
(3,321
)
Interest expense
210

 
171

 
625

 
544

Equity in (earnings) loss of unconsolidated entities
(281
)
 
(785
)
 
(7,483
)
 
(282
)
Income before income taxes
224,928

 
174,722

 
422,637

 
295,402

Income tax expense (benefit)
84,383

 
(2,107,162
)
 
165,393

 
(2,104,661
)
Net income
$
140,545

 
$
2,281,884

 
$
257,244

 
$
2,400,063

 
 
 
 
 
 
 
 
Per share:
 
 
 
 
 
 
 
Basic earnings
$
0.37

 
$
5.92

 
$
0.68

 
$
6.20

Diluted earnings
$
0.37

 
$
5.87

 
$
0.67

 
$
6.14

Cash dividends declared
$
0.05

 
$
0.10

 
$
0.15

 
$
0.10

 
 
 
 
 
 
 
 
Number of shares used in calculation:



 
 
 
 
Basic
373,531

 
382,883

 
376,097

 
384,159

Effect of dilutive securities
3,761

 
3,220

 
3,723

 
3,745

Diluted
377,292

 
386,103

 
379,820

 
387,904




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,
 
2014
 
2013
 
2014
 
2013
Net income
$
140,545

 
$
2,281,884

 
$
257,244

 
$
2,400,063

 
 
 
 
 
 
 
 
Other comprehensive income, net of tax:
 
 
 
 
 
 
 
Change in value of derivatives
21

 
77

 
82

 
273

Other comprehensive income
21

 
77

 
82

 
273

 
 
 
 
 
 
 
 
Comprehensive income
$
140,566

 
$
2,281,961

 
$
257,326

 
$
2,400,336





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, 2014
381,300

 
$
3,813

 
$
3,052,016

 
$
(795
)
 
$
1,593,918

 
$
4,648,952

Stock option exercises
554

 
5

 
6,029

 
—

 
—

 
6,034

Stock awards, net of cancellations
(42
)
 
—

 
—

 
—

 
—

 
—

Dividends declared
—

 
—

 
72

 
—

 
(56,761
)
 
(56,689
)
Stock repurchases
(8,034
)
 
(80
)
 
—

 
—

 
(155,060
)
 
(155,140
)
Stock-based compensation
—

 
—

 
10,586

 
—

 
—

 
10,586

Excess tax benefits (deficiencies) from share-based awards
—

 
—

 
(660
)
 
—

 
—

 
(660
)
Net income
—

 
—

 
—

 
—

 
257,244

 
257,244

Other comprehensive income
—

 
—

 
—

 
82

 
—

 
82

Shareholders' Equity, September 30, 2014
373,778

 
$
3,738

 
$
3,068,043

 
$
(713
)
 
$
1,639,341

 
$
4,710,409

 
 
 
 
 
 
 
 
 
 
 
 
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



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,
 
2014
 
2013
Cash flows from operating activities:
 
 
 
Net income
$
257,244

 
$
2,400,063

Adjustments to reconcile net income to net cash flows provided by (used in)
      operating activities:
 
 
 
Deferred income tax expense
164,460

 
(2,108,756
)
Depreciation and amortization
28,864

 
23,134

Stock-based compensation expense
21,290

 
21,570

Equity in (earnings) loss of unconsolidated entities
(7,483
)
 
(282
)
Distributions of earnings from unconsolidated entities
4,824

 
1,693

Loss on debt retirements
8,584

 
26,930

Other non-cash, net
8,211

 
12,314

Increase (decrease) in cash due to:
 
 
 
Restricted cash
(689
)
 
1,654

Inventories
(384,571
)
 
89,040

Residential mortgage loans available-for-sale
49,600

 
21,967

Other assets
(12,802
)
 
(29,989
)
Accounts payable, accrued and other liabilities
74,102

 
97,607

Income tax liabilities
(9,799
)
 
(1,995
)
Net cash provided by (used in) operating activities
201,835

 
554,950

Cash flows from investing activities:
 
 
 
Distributions from unconsolidated entities
7,624

 
200

Investments in unconsolidated entities
(9
)
 
(1,057
)
Net change in loans held for investment
(6,338
)
 
236

Change in restricted cash related to letters of credit
48,401

 
875

Proceeds from the sale of property and equipment
83

 
9

Capital expenditures
(41,888
)
 
(18,354
)
Cash used for business acquisitions
(77,469
)
 
—

Net cash provided by (used in) investing activities
(69,596
)
 
(18,091
)
Cash flows from financing activities:
 
 
 
Financial Services borrowings (repayments)
(34,070
)
 
(23,697
)
Other borrowings (repayments)
(250,631
)
 
(477,220
)
Stock option exercises
6,034

 
18,549

Stock repurchases
(155,140
)
 
(89,940
)
Dividends paid
(56,944
)
 
(19,317
)
Net cash provided by (used in) financing activities
(490,751
)
 
(591,625
)
Net increase (decrease) in cash and equivalents
(358,512
)
 
(54,766
)
Cash and equivalents at beginning of period
1,580,329

 
1,404,760

Cash and equivalents at end of period
$
1,221,817

 
$
1,349,994

 
 
 
 
Supplemental Cash Flow Information:
 
 
 
Interest paid (capitalized), net
$
(23,236
)
 
$
(18,304
)
Income taxes paid (refunded), net
$
(1,054
)
 
$
(792
)
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, and 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, 2013.

Business acquisition

We acquired certain real estate assets from Dominion Homes in August 2014 for $82.7 million in cash and the assumption of certain payables related to such assets. A total of $5.3 million of the purchase price is expected to be paid subsequent to September 30, 2014. The net assets acquired are located in Columbus, Ohio and Louisville and Lexington, Kentucky and included approximately 8,200 lots, including approximately 400 homes in inventory and control of approximately 900 lots through option contracts. We also assumed a sales order backlog of 622 homes. The acquired net assets were recorded at their estimated fair values. The acquisition of these assets was not material to our results of operations or financial condition.

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, 2014 and December 31, 2013 also included $10.2 million and $3.7 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 includes deposits maintained with financial institutions under cash-collateralized letter of credit agreements (see Note 8) as well as 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, net

Other expense, net consists of the following ($000’s omitted): 
 
Three Months Ended
 
Nine Months Ended
September 30,
 
September 30,
2014
 
2013
 
2014
 
2013
Write-off of deposits and pre-acquisition costs
$
1,391

 
$
811

 
$
4,543

 
$
1,402

Loss on debt retirements (Note 8)
—

 
3,858

 
8,584

 
26,930

Amortization of intangible assets
3,258

 
3,275

 
9,808

 
9,825

Miscellaneous, net (a)
(2,243
)
 
9,111

 
2,626

 
41,009

 
$
2,406

 
$
17,055

 
$
25,561

 
$
79,166


(a)
Includes a charge of $8.0 million and $38.0 million during the three and nine months ended September 30, 2013 resulting from a contractual dispute related to a previously completed luxury community.

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,
2014
 
December 31, 2013
Notes receivable, gross
$
57,466

 
$
59,995

Allowance for credit losses
(27,287
)
 
(27,051
)
Notes receivable, net
$
30,179

 
$
32,944


We also record other receivables from various parties in the normal course of business, including amounts due from municipalities, insurance companies, and vendors. Such receivables are generally reported in other assets. See Residential mortgage loans available-for-sale in Note 1 for a discussion of our receivables related to 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 (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, unvested restricted stock and restricted stock units, 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 excluded 7.1 million and 7.2 million stock options and other potentially dilutive instruments for the three and nine months ended September 30, 2014, respectively, and 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.

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. Our outstanding restricted stock awards, restricted stock units, and deferred shares are considered participating securities.

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



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,
2014
 
2013
 
2014
 
2013
Numerator:
 
 
 
 
 
 
 
Net income
$
140,545

 
$
2,281,884

 
$
257,244

 
$
2,400,063

Less: earnings distributed to participating securities
(124
)
 
(273
)
 
(386
)
 
(273
)
Less: undistributed earnings allocated to participating securities
(820
)
 
(15,884
)
 
(1,362
)
 
(17,526
)
Numerator for basic earnings per share
$
139,601

 
$
2,265,727

 
$
255,496

 
$
2,382,264

Add back: undistributed earnings allocated to participating securities
820

 
15,884

 
1,362

 
17,526

Less: undistributed earnings reallocated to participating securities
(812
)
 
(15,753
)
 
(1,349
)
 
(17,358
)
Numerator for diluted earnings per share
$
139,609

 
$
2,265,858

 
$
255,509

 
$
2,382,432

 
 
 
 
 
 
 
 
Denominator:
 
 
 
 
 
 
 
Basic shares outstanding
373,531

 
382,883

 
376,097

 
384,159

Effect of dilutive securities
3,761

 
3,220

 
3,723

 
3,745

Diluted shares outstanding
377,292

 
386,103

 
379,820

 
387,904

 
 
 
 
 
 
 
 
Earnings per share:
 
 
 
 
 
 
 
Basic
$
0.37

 
$
5.92

 
$
0.68

 
$
6.20

Diluted
$
0.37

 
$
5.87

 
$
0.67

 
$
6.14


Land impairments

We record land impairment valuation adjustments to our communities within Homebuilding home sale cost of revenues. Our evaluations for impairments are based on our best estimates of the future cash flows of our communities. However, if conditions in 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. There were no significant impairments during the three and nine months ended September 30, 2014 or 2013.

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, net.


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



If an 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. No VIEs required consolidation at either September 30, 2014 or December 31, 2013. Separately, certain land option agreements represent financing arrangements due to the remaining purchase price under the land option agreements, even though we generally have no obligation to pay these future amounts. As a result, we recorded $16.8 million and $24.0 million at September 30, 2014 and December 31, 2013, respectively, to land, not owned, under option agreements with a corresponding increase to accrued and other liabilities. The following provides a summary of our interests in land option agreements as of September 30, 2014 and December 31, 2013 ($000’s omitted): 
 
September 30, 2014
 
December 31, 2013
 
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
Land options with VIEs
$
58,197

 
$
771,593

 
$
6,719

 
$
40,486

 
$
661,158

 
$
8,167

Other land options
64,686

 
969,705

 
10,098

 
50,548

 
729,128

 
15,857

 
$
122,883

 
$
1,741,298

 
$
16,817

 
$
91,034

 
$
1,390,286

 
$
24,024


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, 2014 and December 31, 2013, residential mortgage loans available-for-sale had an aggregate fair value of $236.4 million and $287.9 million, respectively, and an aggregate outstanding principal balance of $229.3 million and $278.1 million, respectively. The net gain (loss) resulting from changes in fair value of these loans totaled $(0.3) million and $4.4 million for the three months ended September 30, 2014 and 2013, respectively, and $1.3 million and $2.6 million for the nine months ended September 30, 2014 and 2013. 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 $18.0 million and $18.1 million for the three months ended September 30, 2014 and 2013, respectively, and $48.4 million and $66.4 million for the nine months ended September 30, 2014 and 2013, 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 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 enter into any derivative financial instruments for trading purposes.

At September 30, 2014 and December 31, 2013, we had aggregate interest rate lock commitments of $258.0 million and $175.7 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.

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



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, 2014 and December 31, 2013, we had unexpired forward contracts of $427.3 million and $381.5 million, respectively, and whole loan investor commitments of $22.1 million and $31.7 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 60 days.

The fair values of derivative instruments and their location in the Condensed Consolidated Balance Sheets is summarized below ($000’s omitted):
 
 
September 30, 2014
 
December 31, 2013
 
Other Assets
 
Other Liabilities
 
Other Assets
 
Other Liabilities
Interest rate lock commitments
$
6,298

 
$
182

 
$
3,628

 
$
489

Forward contracts
476

 
1,184

 
4,374

 
34

Whole loan commitments
65

 
67

 
189

 
84

 
$
6,839

 
$
1,433

 
$
8,191

 
$
607


New accounting pronouncements

In January 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update No. 2014-04, “Receivables - Troubled Debt Restructurings by Creditors,” which clarifies when an in substance repossession or foreclosure of residential real estate property collateralizing a consumer mortgage loan has occurred. By doing so, this guidance helps determine when the creditor should derecognize the loan receivable and recognize the real estate property. The guidance is effective for us beginning January 1, 2015 and is not expected to have a material impact on our consolidated financial position, results of operations, or cash flows.
In May 2014, the FASB issued Accounting Standards Update No. 2014-09, “Revenue from Contracts with Customers” (“ASU 2014-09”). The standard is a comprehensive new revenue recognition model that requires revenue to be recognized in a manner to depict the transfer of goods or services to a customer at an amount that reflects the consideration expected to be received in exchange for those goods or services. ASU 2014-09 is effective for us for fiscal and interim periods beginning January 1, 2017 and early application is not permitted. We are currently evaluating the impact that the standard will have on our financial statements.

In June 2014, the FASB issued Accounting Standards Update No. 2014-11, "Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures” ("ASU 2014-11"), which makes limited amendments to ASC 860, "Transfers and Servicing." The ASU requires entities to account for repurchase-to-maturity transactions as secured borrowings, eliminates accounting guidance on linked repurchase financing transactions, and expands disclosure requirements related to certain transfers of financial assets. ASU 2014-11 is effective for us for fiscal periods beginning January 1, 2015 and interim periods beginning April 1, 2015 and is not expected to have a material impact on our consolidated financial position, results of operations, or cash flows.

In August 2014, the FASB issued Accounting Standards Update No. 2014-15, “Disclosure of Uncertainties About an Entity’s Ability to Continue as a Going Concern” (“ASU 2014-15”), which requires management to evaluate, at each annual and interim reporting period, whether there are conditions or events that raise substantial doubt about the entity’s ability to continue as a going concern and provide related disclosures. ASU 2014-15 is effective for annual and interim reporting periods beginning January 1, 2017.

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



2. Inventory and land held for sale

Major components of inventory were as follows ($000’s omitted): 
 
September 30,
2014
 
December 31,
2013
Homes under construction
$
1,404,377

 
$
1,042,147

Land under development
2,243,887

 
2,189,387

Raw land
783,537

 
747,027

 
$
4,431,801

 
$
3,978,561


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. 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,
 
2014
 
2013
 
2014
 
2013
Interest in inventory, beginning of period
$
210,603

 
$
298,575

 
$
230,922

 
$
331,880

Interest capitalized
32,025

 
35,962

 
98,793

 
118,527

Interest expensed
(52,286
)
 
(68,013
)
 
(139,373
)
 
(183,883
)
Interest in inventory, end of period
$
190,342

 
$
266,524

 
$
190,342

 
$
266,524

Interest incurred (a)
$
32,025

 
$
35,962

 
$
98,793

 
$
118,527


(a)
Homebuilding interest incurred includes interest on senior debt and certain other financing arrangements.

Land held for sale

We periodically elect to sell parcels of land to third parties in the event such assets no longer fit into our strategic
operating plans or are zoned for commercial or other development. Land held for sale was as follows ($000’s omitted):
 
 
September 30,
2014
 
December 31,
2013
Land held for sale, gross
$
100,300

 
$
70,003

Net realizable value reserves
(7,138
)
 
(8,268
)
Land held for sale, net
$
93,162

 
$
61,735





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



3. 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, Maryland, Massachusetts, New Jersey, New York, Pennsylvania,
Rhode Island, Virginia
Southeast:
 
Georgia, North Carolina, South Carolina, Tennessee
Florida:
 
Florida
Texas:
 
Texas
North:
 
Illinois, Indiana, Kentucky, Michigan, Minnesota, Missouri, Northern California, Ohio, Oregon, Washington
Southwest:
 
Arizona, 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, 2013.

14
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,
 
2014
 
2013
 
2014
 
2013
Revenues:
 
 
 
 
 
 
 
Northeast
$
185,559

 
$
259,413

 
$
480,495

 
$
555,856

Southeast
253,895

 
234,605

 
668,660

 
602,379

Florida
251,486

 
227,614

 
647,146

 
562,890

Texas
216,837

 
217,897

 
595,975

 
621,972

North
426,165

 
343,748

 
949,757

 
826,054

Southwest
227,331

 
264,465

 
568,228

 
744,534

 
1,561,273

 
1,547,742

 
3,910,261

 
3,913,685

Financial Services
33,452

 
34,336

 
89,544

 
110,571

Consolidated revenues
$
1,594,725

 
$
1,582,078

 
$
3,999,805

 
$
4,024,256

 
 
 
 
 
 
 
 
Income (loss) before income taxes:
 
 
 
 
 
 
 
Northeast
$
28,568

 
$
33,508

 
$
65,873

 
$
62,162

Southeast
42,230

 
37,687

 
105,974

 
78,811

Florida
55,931

 
43,834

 
132,541

 
89,711

Texas
33,730

 
32,111

 
87,952

 
79,015

North
61,599

 
48,674

 
129,699

 
95,303

Southwest
40,812

 
49,508

 
93,198

 
119,908

Other homebuilding (a)
(48,819
)
 
(81,728
)
 
(234,178
)
 
(271,308
)
 
214,051

 
163,594

 
381,059

 
253,602

Financial Services
10,877

 
11,128

 
41,578

 
41,800

Consolidated income before income taxes
$
224,928

 
$
174,722

 
$
422,637

 
$
295,402


(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: losses on debt retirements totaling $8.6 million for the nine months ended September 30, 2014 and $3.9 million and $26.9 million for the three and nine months ended September 30, 2013, respectively; a charge totaling $84.5 million to increase insurance reserves for the nine months ended September 30, 2014; costs associated with the relocation of our corporate headquarters totaling $1.9 million and $7.1 million for the three and nine months ended September 30, 2014, respectively, and $0.3 million and $13.8 million for the three and nine months ended September 30, 2013, respectively; and a charge resulting from a contractual dispute related to a previously completed luxury community totaling $8.0 million and $38.0 million for the three and nine months ended September 30, 2013, respectively.
 

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



 
Operating Data by Segment
 
($000's omitted)
 
September 30, 2014
 
Homes Under
Construction
 
Land Under
Development
 
Raw Land
 
Total
Inventory
 
Total
Assets
Northeast
$
235,007

 
$
266,735

 
$
105,887

 
$
607,629

 
$
712,273

Southeast
183,732

 
300,218

 
114,401

 
598,351

 
634,210

Florida
178,779

 
296,901

 
107,518

 
583,198

 
687,766

Texas
167,372

 
251,916

 
69,455

 
488,743

 
537,105

North
402,923

 
372,773

 
140,384

 
916,080

 
1,004,111

Southwest
204,735

 
568,284

 
204,703

 
977,722

 
1,047,126

Other homebuilding (a)
31,829

 
187,060

 
41,189

 
260,078

 
3,676,400

 
1,404,377

 
2,243,887

 
783,537

 
4,431,801

 
8,298,991

Financial Services
—

 
—

 
—

 
—

 
315,654

 
$
1,404,377

 
$
2,243,887

 
$
783,537

 
$
4,431,801

 
$
8,614,645

 
 
 
 
 
 
 
 
 
 
 
December 31, 2013
 
Homes Under
Construction
 
Land Under
Development
 
Raw Land
 
Total
Inventory
 
Total
Assets
Northeast
$
212,611

 
$
325,241

 
$
106,681

 
$
644,533

 
$
731,259

Southeast
139,484

 
274,981

 
146,617

 
561,082

 
599,271

Florida
140,366

 
295,631

 
104,766

 
540,763

 
618,449

Texas
130,398

 
223,979

 
57,480

 
411,857

 
466,198

North
227,537

 
350,239

 
78,945

 
656,721

 
716,239

Southwest
159,350

 
512,164

 
201,659

 
873,173

 
940,462

Other homebuilding (a)
32,401

 
207,152

 
50,879

 
290,432

 
4,334,591

 
1,042,147

 
2,189,387

 
747,027

 
3,978,561

 
8,406,469

Financial Services
—

 
—

 
—

 
—

 
327,674

 
$
1,042,147

 
$
2,189,387

 
$
747,027

 
$
3,978,561

 
$
8,734,143

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

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



4. 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,
2014
 
December 31,
2013
Investments in joint ventures with debt non-recourse to PulteGroup
$
26,491

 
$
26,532

Investments in other active joint ventures
13,804

 
18,791

Total investments in unconsolidated entities
$
40,295

 
$
45,323

 
 
 
 
Total joint venture debt
$
24,546

 
$
12,408

 
 
 
 
PulteGroup proportionate share of joint venture debt:
 
 
 
Joint venture debt with limited recourse guaranties
$
988

 
$
750

Joint venture debt non-recourse to PulteGroup
9,271

 
3,654

PulteGroup's total proportionate share of joint venture debt
$
10,259

 
$
4,404


We recognized (income) expense from unconsolidated joint ventures of $(0.3) million and $(0.8) million during the three months ended September 30, 2014 and 2013, respectively, and $(7.5) million and $(0.3) million during the nine months ended September 30, 2014 and 2013, respectively. During the nine months ended September 30, 2014 and 2013, we made capital contributions of $0.0 million and $1.1 million, respectively, and received distributions of $12.4 million and $1.9 million, respectively.

The timing of cash obligations under a 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.

5. Shareholders’ equity

During the nine months ended September 30, 2014, we declared three quarterly cash dividends of $0.05 per common share each for an aggregate $56.7 million. In October 2014, the board of directors declared an increase to the quarterly cash dividend to $0.08 per common share.

During the nine months ended September 30, 2014, we repurchased 7.7 million shares under our repurchase authorization for a total of $147.8 million. Such repurchases are reflected as reductions of common stock and retained earnings. At September 30, 2014, we had remaining authorization to repurchase $86.4 million of common shares. In October 2014, our board of directors approved an increase of $750.0 million to such authorization.

Under our stock-based compensation plans, we accept shares as payment under certain conditions related to stock option exercises and vesting of shares, generally related to the payment of minimum tax obligations. During the nine months ended September 30, 2014 and 2013, employees surrendered shares valued at $7.2 million and $6.9 million, respectively, under these plans. Such share transactions are excluded from the above noted stock repurchase authorization.


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



6. 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, changes to tax laws or other circumstances that impact the value of our deferred tax assets, and changes in our unrecognized tax benefits. Our 2014 effective tax rate approximates our blended statutory tax rate. Our tax provisions for the three and nine months ended September 30, 2013 consisted primarily of the reversal of a valuation allowance related to our deferred tax assets.

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 had fully reserved our net deferred tax assets due to the uncertainty of their realization. At September 30, 2013, we 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 third quarter of 2013.

The accounting for deferred taxes is based upon estimates of future results.  Differences between estimated and actual results could result in changes in the valuation of our deferred tax assets that could have a material impact on our consolidated results of operations or financial position. Changes in existing tax laws could also affect actual tax results and the realization of deferred tax assets over time.  Certain states enacted changes to tax laws that impacted the value of our deferred tax assets during 2014. The estimated impact of such changes was recorded to income tax expense during the period.

Unrecognized tax benefits represent the difference between tax positions taken or expected to be taken in a tax return and the benefits recognized for financial statement purposes. At September 30, 2014, we had $159.6 million of gross unrecognized tax benefits and $36.7 million of related accrued interest and penalties. It is reasonably possible within the next twelve months that our gross unrecognized tax benefits may decrease by up to $127.9 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 2004 to 2014.


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



7. 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,
2014
 
December 31,
2013
 
 
 
 
 
 
 
Measured at fair value on a recurring basis:
 
 
 
 
 
 
Residential mortgage loans available-for-sale
 
Level 2
 
$
236,372

 
$
287,933

Interest rate lock commitments
 
Level 2
 
6,116

 
3,139

Forward contracts
 
Level 2
 
(708
)
 
4,340

Whole loan commitments
 
Level 2
 
(2
)
 
105

 
 
 
 
 
 
 
Disclosed at fair value:
 
 
 
 
 
 
Cash and equivalents (including restricted cash)
 
Level 1
 
$
1,246,820

 
$
1,653,044

Financial Services debt
 
Level 2
 
71,594

 
105,664

Senior notes
 
Level 2
 
1,900,488

 
2,070,744


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. There were no material amounts of such assets at either September 30, 2014 or December 31, 2013.

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 $1.8 billion at September 30, 2014 and $2.1 billion at December 31, 2013.


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



8. Debt

Our senior notes are summarized as follows ($000’s omitted):
 
September 30,
2014
 
December 31,
2013
5.20% unsecured senior notes due February 2015 (a)
$
—

 
$
95,633

5.25% unsecured senior notes due June 2015 (a)
235,610

 
233,085

6.50% unsecured senior notes due May 2016 (a)
461,402

 
459,581

7.625% unsecured senior notes due October 2017 (b)
122,730

 
122,663

7.875% unsecured senior notes due June 2032 (a)
299,228

 
299,196

6.375% unsecured senior notes due May 2033 (a)
398,622

 
398,567

6.00% unsecured senior notes due February 2035 (a)
299,462

 
299,443

7.375% unsecured senior notes due June 2046 (a)
—

 
150,000

Total senior notes – carrying value (c)
$
1,817,054

 
$
2,058,168

Estimated fair value
$
1,900,488

 
$
2,070,744


(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 nine months ended September 30, 2014, we retired prior to their scheduled maturity dates senior notes totaling $245.7 million and recorded losses related to these transactions totaling $8.6 million. During the three and nine months ended September 30, 2013, we retired prior to their scheduled maturity dates senior notes totaling $27.0 million and $461.4 million, respectively, and recorded losses related to these transactions totaling $3.9 million and $26.9 million, respectively. Losses on debt repurchase transactions include the write-off of unamortized discounts, premiums, and transaction fees and are reflected in other expense, net.
  
Letter of credit facilities

We maintain a separate cash-collateralized letter of credit agreement with a financial institution. Letters of credit totaling $10.3 million and $58.7 million were outstanding under this agreement (or similar previous agreements with different financial institutions) at September 30, 2014 and December 31, 2013, respectively. Under this agreement, we are required to maintain deposits with the financial institution in amounts approximating the letters of credit outstanding. Such deposits are included in restricted cash. An unsecured letter of credit facility we previously maintained with a bank expired in September 2014.

Revolving credit facility

On July 23, 2014, we entered into a senior unsecured revolving credit facility (the “Revolving Credit Facility”) that matures on July 21, 2017.  The Revolving Credit Facility provides for maximum borrowings of $500 million and contains an uncommitted accordion feature that could increase the size of the Revolving Credit Facility to $1.0 billion, subject to certain conditions and availability of additional bank commitments.  The Revolving Credit Facility also provides for the issuance of letters of credit that reduce available borrowing capacity under the Revolving Credit Facility and may total no more than the greater of: (i) 50% of the size of the facility or (ii) $300 million in the aggregate. The interest rate on borrowings under the Revolving Credit Facility may be based on either the London Interbank Offered Rate or Base Rate plus an applicable margin, as defined.   Letters of credit totaling $195.5 million were outstanding under this facility at September 30, 2014.


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



The Revolving Credit Facility contains financial covenants that require us to maintain a minimum Tangible Net Worth, a minimum Interest Coverage Ratio, and a maximum Debt to Capitalization Ratio (as each term is defined in the Revolving Credit Facility). As of September 30, 2014, we were in compliance with all covenants. Outstanding loans under the Revolving Credit Facility are guaranteed by certain of our wholly-owned subsidiaries.

Financial Services

Pulte Mortgage maintains a master repurchase agreement (the “Repurchase Agreement”) with third party lenders. In September 2014, Pulte Mortgage entered into the Fourth Amendment to the Repurchase Agreement that extended the effective date to September 2015. Effective September 2014, the borrowing capacity under the agreement was set at $150.0 million. The capacity will reduce to $99.8 million in February 2015 and will increase again to $150.0 million in June 2015. The purpose for the change in capacity during the term of the agreement is to lower associated fees during seasonally low volume periods when the additional capacity is unnecessary. Borrowings under the Repurchase Agreement are secured by residential mortgage loans available-for-sale. The Repurchase Agreement contains various affirmative and negative covenants applicable to Pulte Mortgage, including quantitative thresholds related to net worth, net income, and liquidity. Pulte Mortgage had $71.6 million and $105.7 million outstanding under the Repurchase Agreement at September 30, 2014 and December 31, 2013, respectively, and was in compliance with all of its covenants and requirements as of those dates.

9. 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 made by us that the loans met 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 a loan is determined to be faulty, 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.
  

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



Activity in the nine months ended September 30, 2014 reflected a reduction of $18.6 million in liabilities based on our evaluation of required reserves in light of recent settlements of various pending repurchase requests and current conditions. Given the ongoing volatility in the mortgage industry, changes in values of underlying collateral over time, and other 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):

 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2014
 
2013
 
2014
 
2013
Liabilities, beginning of period
$
62,707

 
$
154,421

 
$
124,956

 
$
164,280

Reserves provided and adjustments
—

 
—

 
(18,604
)
 
—

Payments
(1,991
)
 
(8,220
)
 
(45,636
)
 
(18,079
)
Liabilities, end of period
$
60,716

 
$
146,201

 
$
60,716

 
$
146,201


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 10 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 had 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. 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 similar 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 $205.8 million and $975.9 million, respectively, at September 30, 2014, and $183.1 million and $958.3 million, respectively, at December 31, 2013. 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.


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



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.

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.

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,
 
2014
 
2013
 
2014
 
2013
Warranty liabilities, beginning of period
$
61,986

 
$
61,914

 
$
63,992

 
$
64,098

Reserves provided
12,375

 
15,322

 
33,036

 
36,079

Payments
(12,674
)
 
(10,551
)
 
(34,586
)
 
(32,330
)
Other adjustments
(222
)
 
(1,602
)
 
(977
)
 
(2,764
)
Warranty liabilities, end of period
$
61,465

 
$
65,083

 
$
61,465

 
$
65,083


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 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

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



industry is complex, and our coverage varies from policy year to policy year. Our insurance coverage requires a per occurrence deductible up to an overall aggregate retention level. Beginning with the first dollar, amounts paid to satisfy insured claims apply to 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 $734.7 million at September 30, 2014, 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 76% of the total general liability reserves at September 30, 2014. 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. Additionally, the amount of insurance coverage available for each policy period also impacts our recorded reserves. Because of the inherent uncertainty in estimating future losses and the timing of such 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.

During the second quarter of 2014, we recorded a change in estimate increasing reserves by $84.5 million, which is reflected in "Reserves provided" in the below table. Such additional reserves were primarily driven by estimated costs associated with siding repairs in certain previously completed communities that, in turn, impacted actuarial estimates for potential future claims.

Changes in these liabilities were as follows ($000's omitted):
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2014
 
2013
 
2014
 
2013
Balance, beginning of period
$
746,446

 
$
708,142

 
$
668,100

 
$
721,284

Reserves provided
21,385

 
21,439

 
137,666

 
52,266

Payments
(33,168
)
 
(37,983
)
 
(71,103
)
 
(81,952
)
Balance, end of period
$
734,663

 
$
691,598

 
$
734,663

 
$
691,598



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



10. 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.


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



 CONDENSED CONSOLIDATING BALANCE SHEET
SEPTEMBER 30, 2014
($000’s omitted)
 
Unconsolidated
 
Eliminating
Entries
 
Consolidated
PulteGroup,
Inc.
 
PulteGroup,
Inc.
 
Guarantor
Subsidiaries
 
Non-Guarantor
Subsidiaries
 
ASSETS
 
 
 
 
 
 
 
 
 
Cash and equivalents
$
862

 
$
1,169,490

 
$
51,465

 
$
—

 
$
1,221,817

Restricted cash
10,298

 
2,301

 
12,404

 
—

 
25,003

House and land inventory
—

 
4,430,930

 
871

 
—

 
4,431,801

Land held for sale
—

 
92,128

 
1,034

 
—

 
93,162

Land, not owned, under option
       agreements
—

 
16,817

 
—

 
—

 
16,817

Residential mortgage loans available-
       for-sale
—

 
—

 
236,372

 
—

 
236,372

Investments in unconsolidated entities
74

 
36,091

 
4,130

 
—

 
40,295

Other assets
35,240

 
403,047

 
62,457

 
—

 
500,744

Intangible assets
—

 
126,340

 
—

 
—

 
126,340

Deferred tax assets, net
1,909,922

 
17

 
12,355

 
—

 
1,922,294

Investments in subsidiaries and
       intercompany accounts, net
4,848,387

 
673,726

 
6,178,709

 
(11,700,822
)
 
—

 
$
6,804,783

 
$
6,950,887

 
$
6,559,797

 
$
(11,700,822
)
 
$
8,614,645

LIABILITIES AND SHAREHOLDERS' EQUITY
 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
 
 
Accounts payable, customer deposits,
       accrued and other liabilities
$
81,104

 
$
1,576,396

 
$
161,874

 
$
—

 
$
1,819,374

Income tax liabilities
196,216

 
(2
)
 
—

 
—

 
196,214

Financial Services debt
—

 
—

 
71,594

 
—

 
71,594

Senior notes
1,817,054

 
—

 
—

 
—

 
1,817,054

Total liabilities
2,094,374

 
1,576,394

 
233,468

 
—

 
3,904,236

Total shareholders’ equity
4,710,409

 
5,374,493

 
6,326,329

 
(11,700,822
)
 
4,710,409

 
$
6,804,783

 
$
6,950,887

 
$
6,559,797

 
$
(11,700,822
)
 
$
8,614,645



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



CONDENSED CONSOLIDATING BALANCE SHEET
DECEMBER 31, 2013
($000’s omitted)
 
Unconsolidated
 
Eliminating
Entries
 
Consolidated
PulteGroup,
Inc.
 
PulteGroup,
Inc.
 
Guarantor
Subsidiaries
 
Non-Guarantor
Subsidiaries
 
ASSETS
 
 
 
 
 
 
 
 
 
Cash and equivalents
$
262,364

 
$
1,188,999

 
$
128,966

 
$
—

 
$
1,580,329

Restricted cash
58,699

 
2,635

 
11,381

 
—

 
72,715

House and land inventory
—

 
3,977,851

 
710

 
—

 
3,978,561

Land held for sale
—

 
60,701

 
1,034

 
—

 
61,735

Land, not owned, under option
       agreements
—

 
24,024

 
—

 
—

 
24,024

Residential mortgage loans available-
       for-sale
—

 
—

 
287,933

 
—

 
287,933

Investments in unconsolidated entities
68

 
41,319

 
3,936

 
—

 
45,323

Other assets
50,251

 
359,228

 
51,142

 
—

 
460,621

Intangible assets
—

 
136,148

 
—

 
—

 
136,148

Deferred tax assets, net
2,074,137

 
17

 
12,600

 
—

 
2,086,754

Investments in subsidiaries and
       intercompany accounts, net
4,532,950

 
(16,513
)
 
5,939,784

 
(10,456,221
)
 
—

 
$
6,978,469

 
$
5,774,409

 
$
6,437,486

 
$
(10,456,221
)
 
$
8,734,143

LIABILITIES AND SHAREHOLDERS' EQUITY
 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
 
 
Accounts payable, customer deposits,
       accrued and other liabilities
$
65,334

 
$
1,413,752

 
$
236,258