Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

In 2012, new home sales in the U.S. increased for the first time since 2005. Although this volume remains very low compared to historical levels, the improved environment and our restructuring actions contributed to our return to profitability in 2012 as net new orders, closings, revenues, gross margin, and overhead leverage all improved compared with 2011. During the year, our net new orders increased 25% over 2011 from 4% fewer active communities. We also generated significant positive operating cash flow, highlighting some of the benefits of our efforts to improve our capital efficiency. By using our existing land assets more efficiently, allocating capital more effectively, and controlling unsold ("spec") inventory, we continued to enhance our balance sheet and position the Company to deliver higher long-term returns.

While the timing of a broad, sustainable recovery in the homebuilding industry remains uncertain, we believe that new home demand is moving along a path toward recovery. The value in new housing resulting from affordable prices, low mortgage rates, escalating rents, and more energy-efficient homes is providing consumers with a compelling reason to buy a new home, especially relative to the ever more expensive rental market and the tightened supply of available existing homes. In the short term, we believe that 2013 will be a better year for U.S. housing than 2012 in spite of continued high levels of unemployment and related low levels of consumer confidence, a challenging U.S. macroeconomic environment, and potential regulatory reforms that may impact the housing and mortgage industries. In the long term, we continue to believe that the national publicly-traded builders will have a competitive advantage over local builders through their ability to leverage economies of scale at a local level, access to more reliable and lower cost financing through the capital markets, ability to control and entitle large land positions, and greater geographic and product diversification. Among the national publicly-traded peer group, we believe that builders with more significant land positions, broad geographic and product diversity, and sustainable capital positions will benefit as market conditions recover. We continue to focus on our primary operational objectives:

•	Improving our inventory turns;

•	More effectively allocating the capital invested in our business using a risk-based portfolio approach;

•	Enhancing revenues through more strategic pricing, including establishing clear business models for each of our brands based on systematic, consumer-driven input, optimizing our pricing through the expanded use of options and lot premiums, and lessening our reliance on spec home sales;

•	Reducing our house costs through common house plan management, value-engineering our house plans, and working with suppliers to reduce costs; and

•	Maintaining an efficient overhead structure.

Continued focus on these operational objectives, combined with improvements in industry conditions, have resulted in a return to profitability in our homebuilding operations and an increase in profits in our financial services businesses.

The following is a summary of our operating results by line of business ($000's omitted, except per share data):

	Years Ended December 31,
	2012				2011				2010
Income (loss) before income taxes:
Homebuilding	$	157,991			$	(275,830	)		$	(1,240,155	)
Financial Services	25,563				(34,470		)		5,609
Income (loss) from continuing operations before income taxes	183,554				(310,300		)		(1,234,546		)
Income tax expense (benefit)	(22,591		)		(99,912		)		(137,817		)
Net income (loss)	$	206,145			$	(210,388	)		$	(1,096,729	)
Per share data - assuming dilution:
Net income (loss)	$	0.54			$	(0.55	)		$	(2.90	)

•	The Homebuilding income (loss) before income taxes included charges related to the following items ($000's omitted):

	2012				2011				2010
Land-related charges (see Note 5)	$	17,195			$	35,786			$	216,352
Loss on debt retirements (see Note 7)	32,071				5,638				38,920
Restructuring costs (see Note 3)	11,787				19,696				50,718
Goodwill impairments (see Note 2)	—				240,541				656,298
Insurance-related adjustments (see Note 13)	—				—				280,390
	$	61,053			$	301,661			$	1,242,678

For additional information on each of the above, see the applicable Notes to the Consolidated Financial Statements.

Our Homebuilding operating results improved significantly from the losses experienced in 2011 and 2010 as the result of the lower charges listed in the above table, as well as higher revenues, increased gross margins, and improved overhead leverage.

•

The Financial Services income in 2012 compared to the loss in 2011 was due to higher origination volumes, improved loan pricing, and lower loss reserves related to loans originated in previous years. Such loss reserves totaled $49.0 million in 2012, compared with $59.3 million in 2011 (see Note 13 to the Consolidated Financial Statements). The Financial Services loss in 2011 compared to the income in 2010 was primarily due to increased loan loss reserves in 2011 as such reserves totaled $16.9 million in 2010.

•	The income tax benefits in 2012, 2011, and 2010 were attributable primarily to the favorable resolution of certain federal and state income tax matters.

Homebuilding Operations

The following is a summary of income (loss) before income taxes for our Homebuilding operations ($000’s omitted):

	Years Ended December 31,
	2012				FY 2012 vs. FY 2011			2011				FY 2011 vs. FY 2010			2010
Home sale revenues	$	4,552,412			15	%		$	3,950,743			(11	)%		$	4,419,812
Land sale revenues	106,698				29	%		82,853				198	%		27,815
Total Homebuilding revenues	4,659,110				16	%		4,033,596				(9	)%		4,447,627
Home sale cost of revenues (a)	3,833,451				11	%		3,444,398				(14	)%		4,006,385
Land sale cost of revenues (b)	94,880				60	%		59,279				11	%		53,555
Selling, general and administrative expenses ("SG&A") (c)	514,457				(1	)%		519,583				(42	)%		895,102
Equity in (earnings) loss of unconsolidated entities (d)	(3,873		)		21	%		(3,194		)		12	%		(2,843		)
Other expense (income), net (e)	66,298				(77	)%		293,102				(61	)%		742,385
Interest income, net	(4,094		)		9	%		(3,742		)		(45	)%		(6,802		)
Income (loss) before income taxes	$	157,991			157	%		$	(275,830	)		78	%		$	(1,240,155	)
Supplemental data:
Gross margin from home sales	15.8		%		300 bps			12.8		%		340 bps			9.4		%
SG&A as a percentage of home sale revenues	11.3		%		(190) bps			13.2		%		(710) bps			20.3		%
Closings (units)	16,505				8	%		15,275				(11	)%		17,095
Average selling price	$	276			7	%		$	259			0	%		$	259
Net new orders:
Units	19,039				25	%		15,215				0	%		15,148
Dollars (f)	$	5,424,300			37	%		$	3,953,829			1	%		$	3,898,950
Cancellation rate	15		%					19		%					19		%
Active communities at December 31	670				(4	)%		700				(11	)%		786
Backlog at December 31:
Units	6,458				65	%		3,924				(2	)%		3,984
Dollars	$	1,931,538			82	%		$	1,059,649			0	%		$	1,056,563

(a)	Includes the amortization of capitalized interest. Home sale cost of revenues also includes land and community valuation adjustments of $13.4 million, $15.9 million, and $169.7 million for 2012, 2011, and 2010, respectively.

(b)	Includes net realizable value adjustments for land held for sale of $1.5 million, $9.8 million, and $39.1 million for 2012, 2011, and 2010, respectively.

(c)	SG&A for 2010 includes the adverse impact of insurance reserve adjustments totaling $280.4 million.

(d)	Includes impairments of our investments in unconsolidated joint ventures, which totaled $1.9 million in 2010.

(e)

Includes goodwill impairment charges of $240.5 million and $656.3 million in 2011 and 2010, respectively. Also includes the write-off of deposits and pre-acquisition costs for land option contracts we elected not to pursue of $2.3 million, $10.0 million, and $5.6 million in 2012, 2011, and 2010, respectively, and net losses related to the redemption of debt totaling $32.1 million, $5.6 million, and $38.9 million in 2012, 2011, and 2010, respectively.

(f)	Net new order dollars represent a composite of new order dollars combined with other movements of the dollars in backlog related to cancellations and change orders.

Home sale revenues

Home sale revenues for 2012 were higher than 2011 by $601.7 million, or 15%. The increase was attributable to a 7% increase in the average selling price combined with an 8% increase in closings. The increase in average selling price reflects an ongoing shift in our revenue mix toward move-up buyers and improved market conditions. The increase in closings was realized from 4% fewer active communities and was concentrated primarily in our North and Southwest segments.

Home sale revenues for 2011 were lower than 2010 by $469.1 million, or 11%. The decrease was attributable to an 11% decrease in closings as average selling prices remained stable from 2010 to 2011. The decline in closings for 2011 compared with 2010 occurred in each of our Homebuilding segments, except for Florida, and resulted primarily from lower industry volumes, in part due to the expiration of the federal homebuyer tax credit that existed during 2010. This tax credit favorably impacted new orders and closings during the first half of 2010, in part we believe by pulling forward customer demand. The 11% decrease in our active communities also contributed to the lower closings.

Home sale gross margins

Home sale gross margins were 15.8% in 2012, compared with 12.8% in 2011 and 9.4% in 2010. Gross margins during 2012 and 2011 benefited from lower land and community valuation adjustments of $13.4 million and $15.9 million, respectively, compared to $169.7 million in 2010. The increase in gross margins was despite increased capitalized interest amortization, which reduced gross margins by 10 basis points and 70 basis points in 2012 and 2011, respectively, as compared with the comparable prior year periods. The higher capitalized interest amortization was attributable primarily to debt assumed with our 2009 merger with Centex.

Excluding the impact of land and community valuation adjustments and capitalized interest amortization, adjusted home sale gross margins improved to 20.9% in 2012 from 17.9% in 2011 and 16.7% in 2010 (see the Non-GAAP Financial Measures section for a reconciliation of adjusted home sale gross margins). These improved gross margins reflect a combination of factors, including shifts in the product mix of homes closed toward move-up buyers, better alignment of our product offering with current market conditions, contributions from our strategic pricing and house cost reduction objectives, and, in 2012, an improved demand and pricing environment.

Land sales

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 sale revenues and their related gains or losses vary between periods, depending on the timing of land sales and our strategic operating decisions. Land sales had margin contributions of $11.8 million, $23.6 million, and $(25.7) million in 2012, 2011, and 2010, respectively. These margin contributions included net realizable value adjustments related to land held for sale totaling $1.5 million, $9.8 million, and $39.1 million in 2012, 2011, and 2010, respectively.

SG&A

In order to reduce overhead costs, we have reconfigured our organization in recent years to better align our overhead structure with expected volumes. These actions have included consolidating many local divisions along with reducing corporate and support staffing across a number of functions. As a result, SG&A as a percentage of home sale revenues dropped from 13.2% in 2011 to 11.3% in 2012. The gross dollar amount of our SG&A decreased $5.1 million, or 1%, in 2012 compared to 2011 due to this improved overhead leverage, partially offset primarily by higher incentive compensation resulting from our improved operating results.

The gross dollar amount of our SG&A decreased $375.5 million, or 42%, in 2011 compared to 2010 while SG&A as a percentage of home sale revenues dropped to 13.2% in 2011 from 20.3% in 2010. SG&A in 2010 included $280.4 million in insurance reserve adjustments, substantially all of which related to general liability construction defect claims (see Note 13 to the Consolidated Financial Statements for additional discussion of insurance reserve adjustments). Excluding these insurance reserve adjustments, SG&A as a percentage of home sale revenues was 13.2% and 13.9% in 2011 and 2010, respectively. (See the Non-GAAP Financial Measures section for a reconciliation of SG&A as a percentage of home sale revenue, excluding insurance reserve adjustments). This improved overhead leverage resulted from a combination of better matching our overall cost structure with the current business environment and lower severance and equity compensation expense in 2011 compared to 2010.

Equity in (earnings) loss of unconsolidated entities

Equity in (earnings) loss of unconsolidated entities was $(3.9) million, $(3.2) million, and $(2.8) million for 2012, 2011, and 2010, respectively. The majority of our unconsolidated entities represent land development joint ventures. As a result, the timing of income and losses varies between periods depending on the timing of transactions and circumstances specific to each entity.

Other expense (income), net

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

	2012				2011				2010
Write-offs of deposits and pre-acquisition costs (Note 4)	$	2,278			$	10,002			$	5,594
Loss on debt retirements (Note 7)	32,071				5,638				38,920
Lease exit and related costs (Note 3)	7,306				9,900				28,378
Amortization of intangible assets (Note 1)	13,100				13,100				13,100
Goodwill impairments (Note 2)	—				240,541				656,298
Miscellaneous expense (income), net	11,543				13,921				95
	$	66,298			$	293,102			$	742,385

For additional information on each of the above, see the applicable Notes to the Consolidated Financial Statements. Miscellaneous expense (income), net includes $5.1 million in 2012 and $17.1 million in 2011 related to the write-down of notes receivable.

Interest income, net

The increase in interest income, net for 2012 compared with 2011 resulted primarily from higher invested cash balances. The decrease in interest income, net in 2011 compared with 2010 resulted from lower invested cash balances.

Net new orders

Net new orders increased 25% in 2012 compared with 2011 while selling from 4% fewer active communities in 2012 (670 at December 31, 2012). The increase in net new orders was broad-based as each of our reportable segments experienced increases during 2012, with the largest increases occurring in our North and Southwest segments. The cancellation rate (canceled orders for the period divided by gross new orders for the period) was 15% in 2012 compared to 19% in 2011. Ending backlog units, which represent orders for homes that have not yet closed, increased 65% at December 31, 2012 compared with December 31, 2011, due to the increase in net new orders.

Net new order levels were essentially flat for 2011 compared with 2010. Net new orders reflected the impact of the federal homebuyer tax credit that expired during 2010, which favorably impacted new orders during the first half of 2010, and the reduced number of active communities in 2011. At December 31, 2011, we had 700 active communities, a decrease of 11% from December 31, 2010. The cancellation rate for 2011 was unchanged from 2010 at 19%. Ending backlog was essentially flat at December 31, 2011 compared with December 31, 2010, consistent with the overall new order levels.

Homes in production

The following is a summary of our homes in production at December 31, 2012 and 2011:

		2012			2011
Sold		4,162			2,640
Unsold
Under construction		753			1,381
Completed		503			1,481
		1,256			2,862
Models		1,119			1,278
Total		6,537			6,780

The slight decrease in homes in production at December 31, 2012 compared to December 31, 2011 is the result of a significant reduction in homes unsold to customers ("spec homes"), largely offset by a large increase in the number of sold homes in production. Reducing our reliance on sales of spec homes is a component of our strategic pricing and inventory turns objectives, so we focused in 2012 on lowering the overall level of spec home inventory, especially completed specs ("final specs"). The increase in sold homes in production resulted from the significant increase in net new orders and backlog.

Controlled lots

The following is a summary of our lots under control at December 31, 2012 and 2011:

		December 31, 2012									December 31, 2011
		Owned			Optioned			Controlled			Owned			Optioned			Controlled
Northeast		9,211			2,655			11,866			10,540			2,121			12,661
Southeast		13,372			2,756			16,128			15,016			3,215			18,231
Florida		23,906			3,689			27,595			26,444			2,136			28,580
Texas		12,218			3,685			15,903			14,759			4,231			18,990
North		12,946			2,603			15,549			15,084			1,676			16,760
Southwest		31,407			1,427			32,834			35,090			698			35,788
Total		103,060			16,815			119,875			116,933			14,077			131,010
Developed (%)		27	%		34	%		28	%		28	%		38	%		29	%

Of our controlled lots, 103,060 and 116,933 were owned and 9,634 and 10,060 were under option agreements approved for purchase at December 31, 2012 and 2011, respectively. In addition, there were 7,181 and 4,017 lots under option agreements pending approval at December 31, 2012 and 2011, respectively. While we continue to purchase land positions where it makes strategic and economic sense to do so, the reduction in lots resulting from closings, land disposition activity, and withdrawals from land option contracts exceeded the number of lots added by new transactions during the year ended December 31, 2012. This trend is consistent with our focus on improving our inventory turns.

The remaining purchase price under our land option agreements totaled $923.4 million at December 31, 2012. These land option agreements, which generally may be canceled at our discretion and in certain cases extend over several years, are secured by deposits and pre-acquisition costs totaling $70.1 million, of which only $2.9 million is refundable.

Non-GAAP Financial Measures

This report contains information about our home sale gross margins and selling, general and administrative expenses (“SG&A”) reflecting certain adjustments. These measures are considered non-GAAP financial measures under the SEC's rules and should be considered in addition to, rather than as a substitute for, the comparable GAAP financial measures as measures of our operating performance. Management and our local divisions use these measures in evaluating the operating performance of each community and in making strategic decisions regarding sales pricing, construction and development pace, product mix, and other daily operating decisions. We believe they are relevant and useful measures to investors for evaluating our performance through (1) gross profit generated on homes delivered during a given period and (2) the efficiency of our overhead cost structure and for comparing our operating performance to other companies in the homebuilding industry. Although other companies in the homebuilding industry report similar information, the methods used may differ. We urge investors to understand the methods used by other companies in the homebuilding industry to calculate gross margins and SG&A and any adjustments thereto before comparing our measures to that of such other companies.

The following tables set forth reconciliations of these non-GAAP financial measures to the GAAP financial measures that management believes to be most directly comparable ($000's omitted):

Home sale gross margin
	Years Ended December 31,
	2012				2011				2010
Home sale revenues	$	4,552,412			$	3,950,743			$	4,419,812
Home sale cost of revenues	3,833,451				3,444,398				4,006,385
Home sale gross margin	718,961				506,345				413,427
Add:
Land and community valuation adjustments (a)	$	6,969			$	10,498			$	141,592
Capitalized interest amortization (a)	224,291				189,382				180,918
Adjusted home sale gross margin	$	950,221			$	706,225			$	735,937
Home sale gross margin as a percentage of home sale revenues	15.8		%		12.8		%		9.4		%
Adjusted home sale gross margin as a percentage of home sale revenues	20.9		%		17.9		%		16.7		%

(a)	Write-offs of capitalized interest related to land and community valuation adjustments are reflected in capitalized interest amortization.

SG&A
	Years Ended December 31,
	2012				2011				2010
Home sale revenues	$	4,552,412			$	3,950,743			$	4,419,812
SG&A	$	514,457			$	519,583			$	895,102
Less: Insurance reserve adjustments (a)	—				—				280,390
SG&A excluding insurance reserve adjustments	$	514,457			$	519,583			$	614,712
SG&A as a percentage of home sale revenues	11.3		%		13.2		%		20.3		%
SG&A excluding insurance reserve adjustments as a percentage of home sale revenues	11.3		%		13.2		%		13.9		%

(a)	Adjustments to recorded insurance reserves, primarily related to general liability exposures.

Homebuilding Segment Operations

Our homebuilding operations represent our core business. Homebuilding offers a broad product line to meet the needs of homebuyers in our targeted markets. As of December 31, 2012, we conducted our operations in 58 markets located throughout 28 states. 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.

The following table presents selected financial information for our reportable Homebuilding segments:

	Operating Data by Segment ($000's omitted)
	Years Ended December 31,
	2012				FY 2012 vs. FY 2011			2011				FY 2011 vs. FY 2010			2010
Home sale revenues:
Northeast	$	722,691			1	%		$	714,609			(5	)%		$	754,280
Southeast	689,163				2	%		675,124				(10	)%		752,509
Florida	620,156				11	%		557,865				3	%		539,996
Texas	666,759				8	%		615,319				(4	)%		638,424
North	989,510				36	%		727,085				(16	)%		861,559
Southwest	864,133				31	%		660,741				(24	)%		873,044
	$	4,552,412			15	%		$	3,950,743			(11	)%		$	4,419,812
Income (loss) before income taxes:
Northeast	$	73,345			150	%		$	29,320			(15	)%		$	34,619
Southeast	64,678				44	%		45,060				92	%		23,454
Florida	73,472				63	%		44,946				186	%		(51,995		)
Texas	60,979				83	%		33,329				108	%		16,026
North	84,597				(b)			(12,376		)		(b)			571
Southwest	79,887				118	%		36,647				157	%		(64,140		)
Other homebuilding (a)	(278,967		)		38	%		(452,756		)		62	%		(1,198,690		)
	$	157,991			157	%		$	(275,830	)		78	%		$	(1,240,155	)
Closings (units):
Northeast	1,800				(4	)%		1,880				(10	)%		2,083
Southeast	2,757				(1	)%		2,771				(10	)%		3,095
Florida	2,340				4	%		2,251				1	%		2,224
Texas	3,487				5	%		3,327				(7	)%		3,563
North	3,103				20	%		2,579				(16	)%		3,055
Southwest	3,018				22	%		2,467				(20	)%		3,075
	16,505				8	%		$	15,275			(11	)%		17,095
Average selling price:
Northeast	$	401			6	%		$	380			5	%		$	362
Southeast	250				2	%		244				0	%		243
Florida	265				7	%		248				2	%		243
Texas	191				3	%		185				3	%		179
North	319				13	%		282				0	%		282
Southwest	286				7	%		268				(6	)%		284
	$	276			7	%		$	259			0	%		$	259

(a)	Other homebuilding includes the amortization of intangible assets, goodwill impairment, amortization of capitalized interest, net losses related to the redemption of debt, and other costs not allocated to the operating segments.

(b)	Percentage not meaningful

The following tables present additional selected financial information for our reportable Homebuilding segments:

		Operating Data by Segment ($000's omitted)
		Years Ended December 31,
		2012				FY 2012 vs. FY 2011			2011				FY 2011 vs. FY 2010			2010
Net new orders - units:
Northeast		1,997				14	%		1,749				6	%		1,650
Southeast		3,066				16	%		2,642				(4	)%		2,747
Florida		2,747				19	%		2,314				13	%		2,046
Texas		4,117				26	%		3,278				5	%		3,129
North		3,661				39	%		2,635				(3	)%		2,716
Southwest		3,451				33	%		2,597				(9	)%		2,860
		19,039				25	%		15,215				0	%		15,148
Net new orders - dollars:
Northeast		$	820,609			22	%		$	674,134			9	%		$	617,899
Southeast		787,286				22	%		645,993				(3	)%		662,650
Florida		735,250				26	%		581,778				18	%		494,587
Texas		807,455				33	%		606,239				6	%		570,860
North		1,228,743				64	%		748,089				(1	)%		757,639
Southwest		1,044,957				50	%		697,596				(12	)%		795,315
		$	5,424,300			37	%		$	3,953,829			1	%		$	3,898,950
Cancellation rates:
Northeast		12		%					14		%					16		%
Southeast		13		%					16		%					16		%
Florida		12		%					13		%					11		%
Texas		22		%					28		%					29		%
North		13		%					17		%					17		%
Southwest		15		%					19		%					18		%
		15		%					19		%					19		%
Unit backlog:
Northeast		622				46	%		425				(24	)%		556
Southeast		911				51	%		602				(18	)%		731
Florida		1,065				62	%		658				11	%		595
Texas		1,455				76	%		825				(6	)%		874
North		1,267				79	%		709				9	%		653
Southwest		1,138				61	%		705				23	%		575
		6,458				65	%		3,924				(2	)%		3,984
Backlog dollars:
Northeast		$	276,851			55	%		$	178,934			(18	)%		$	219,409
Southeast		252,656				63	%		154,533				(16	)%		183,664
Florida		289,133				66	%		174,039				16	%		150,126
Texas		294,623				91	%		153,927				(6	)%		163,007
North		446,741				115	%		207,507				11	%		186,503
Southwest		371,534				95	%		190,709				24	%		153,854
		$	1,931,538			82	%		$	1,059,649			0	%		$	1,056,563

The following table presents additional selected financial information for our reportable Homebuilding segments:

		Operating Data by Segment ($000's omitted)
		Years Ended December 31,
		2012				FY 2012 vs. FY 2011			2011				FY 2011 vs. FY 2010			2010
Land-related charges*:
Northeast		$	1,794			(64	)%		$	4,958			17	%		$	4,235
Southeast		1,363				(44	)%		2,429				(83	)%		14,141
Florida		214				(95	)%		3,999				(93	)%		56,833
Texas		556				(33	)%		828				(88	)%		6,814
North		4,546				(69	)%		14,867				(47	)%		28,076
Southwest		2,254				(31	)%		3,263				(96	)%		78,123
Other homebuilding		6,468				19	%		5,442				(81	)%		28,130
		$	17,195			(52	)%		$	35,786			(83	)%		$	216,352

*

Land-related charges include land and community valuation adjustments, net realizable value adjustments for land held for sale, write-offs of deposits and pre-acquisition costs for land option contracts we elected not to pursue, and impairments of our investments in unconsolidated entities. Other homebuilding consists primarily of write-offs of capitalized interest. See and to the Consolidated Financial Statements for additional discussion of these charges.

Northeast:

For 2012, Northeast home sale revenues increased 1% compared with 2011 due to a 6% increase in the average selling price, offset in part by a 4% decrease in closings. The increase in average selling price occurred primarily in the Northeast Corridor and Mid-Atlantic, while the decrease in closings was concentrated in the Northeast Corridor and was due to a significant decrease in active communities. The significant increase in income before income taxes was due to moderately improved gross margins and $21.9 million of expense in 2011 related to the write-down of a note receivable and unfavorable resolution of certain contingencies. Net new orders increased 14%, led by our operations in New England.

For 2011, Northeast home sale revenues decreased 5% compared with 2010 due to a 10% decrease in closings offset in part by a 5% increase in the average selling price. The reduction in closing volumes was primarily due to fewer closings in our Mid-Atlantic division, in part due to a lower active community count. The decreased income before income taxes was primarily due to expense of $21.9 million in 2011 related to the write-down of a note receivable and unfavorable resolution of certain contingencies. Such expense was partially offset by improved gross margin compared to the prior year. Net new orders increased 6% in 2011, led by our operations in the Northeast Corridor and Mid-Atlantic.

Southeast:

For 2012, Southeast home sale revenues increased 2% compared with 2011 due to a 2% increase in the average selling price, partially offset by a 1% decrease in closings. The increase in average selling price was concentrated in Georgia and Tennessee. The decrease in closing volumes was primarily due to a moderate decrease in Raleigh. The increased income before income taxes was due to moderately improved gross margins. Net new orders increased 16% in 2012 and reflected increases across all divisions.

For 2011, Southeast home sale revenues decreased 10% compared with 2010 due to a 10% decrease in closings as there was no change in the average selling price. The reduction in closing volumes was primarily due to fewer closings in our Georgia division as well as a lower active community count across all divisions. Gross margin improved compared with the prior year period. The increased income before income taxes was also due to lower land-related charges. Net new orders decreased 4% compared with 2010, due in part to decreased activity in our Tennessee division.

Florida:

For 2012, Florida home sale revenues increased 11% compared with 2011 due to a 7% increase in the average selling price and a 4% increase in closings. The increase in income before income taxes for 2012 was attributable to significantly improved gross margins and overhead leverage, as well as lower land-related charges. Net new orders increased by 19% in 2012 evenly across North and South Florida.

For 2011, Florida home sale revenues increased 3% compared with 2010 due to a 1% increase in closings combined with a 2% increase in the average selling price. The majority of this improvement was due to increased closing volumes in North Florida. The income before income taxes in 2011 was attributable to improved gross margins and significantly lower land-related charges than in 2010. Net new order units increased by 13% in 2011, in part due to grand openings or grand re-openings at several large communities.

Texas:

For 2012, Texas home sale revenues increased 8% compared with the prior year period due to a 5% increase in closings combined with a 3% increase in average selling price. The increase in closings was experienced across all markets, but was concentrated in Houston and San Antonio. The increase in average selling price was concentrated in Central Texas and Dallas. The significant increase in income before income taxes for 2012 was attributable to moderately improved gross margins and overhead leverage. Net new orders increased by 26% for 2012 and reflected increases across all divisions.

For 2011, Texas home sale revenues decreased 4% compared with 2010 due to a 7% decrease in closings partially offset by a 3% increase in the average selling price. The reduction in closing volumes was mainly due to Central Texas and San Antonio. The increased income before income taxes in 2011 was attributable to improved gross margins and lower land-related charges than in the prior year period. Net new order units increased by 5% for 2011, in part due to the grand opening of a large community in Houston.

North:

For 2012, North home sale revenues increased 36% compared with the prior year period due to a 20% increase in closings and a 13% increase in average selling price. The increase in closing volumes was broad-based across all divisions, with the largest increases coming from our Michigan and Indianapolis operations. The increase in average selling price was due to increases at all divisions except Michigan, with the most significant increases in Minnesota and the Pacific Northwest. The substantial increase in income before income taxes, as compared to the loss experienced in 2011, was due to the increased revenues, significantly improved gross margins and overhead leverage, a significant reduction in land-related charges, and gains related to land sale transactions. Net new orders increased by 39% in 2012 compared with 2011, and reflected moderate to significant increases across all divisions, with the largest increases in Michigan and Northern California.

For 2011, North home sale revenues decreased 16% compared with 2010 due to a 16% decrease in closings as there was no change in average selling price. The decrease in closing volumes was due to significantly fewer closings in our Minnesota, St. Louis, and Northern California divisions. Gross margin decreased slightly. The loss before income taxes was primarily due to the reduced revenues, offset in part by reduced land-related charges. Net new order units decreased by 3% in 2011 compared with 2010, primarily in our Minnesota, St. Louis, and Northern California divisions. The sales volumes for our Northern California division reflect the impact of the state homebuyer tax credit that existed in California during 2010. The expiration of this tax credit exacerbated the already challenging local market conditions. These declines were partially offset by improvements in our other North divisions.

Southwest:

For 2012, Southwest home sale revenues increased 31% compared with the prior year period due to a 22% increase in closings and a 7% increase in average selling price. The increase in average selling price occurred across all divisions. The significant increase in income before income taxes was due to the higher revenues, moderately improved gross margins, and better overhead leverage. In 2011, the Southwest also benefited from land sale gains totaling $15.5 million. Net new orders increased by 33% in 2012 compared with 2011 with significant increases across all divisions, except Colorado.

For 2011, Southwest home sale revenues decreased 24% compared with 2010 due to a 20% decrease in closings and a 6% decrease in average selling price. The decreases were due to weakness in each of our divisions combined with the close-out in late 2010 of our luxury condo community in Hawaii that had average selling prices in excess of $1 million. The increase in income before income taxes was primarily due to improved gross margins and the significant decrease in land-related charges. The Southwest also benefited from land sale gains totaling $15.5 million in 2011. Net new order units decreased by 9% in 2011 compared with 2010, due to the close-out of our community in Hawaii as well as reduced activity in our Las Vegas and Southern California markets. Sales volumes for Southern California reflect the impact of the state homebuyer tax credit that existed in California during 2010, the expiration of which exacerbated the already challenging local market conditions.

Financial Services Operations

We conduct our Financial Services operations, which include mortgage and title operations, through Pulte Mortgage and other subsidiaries. In originating mortgage loans, we initially use our own funds, including funds available pursuant to credit agreements with either third parties or with the Company. Substantially all of the loans we originate are sold in the secondary market within a short period of time after origination, generally within 30 days. We sell the servicing rights for the loans we originate through fixed price servicing sales contracts to reduce the risks and costs inherent in servicing loans. This strategy results in owning the servicing rights for only a short period of time. Operating as a captive business model primarily targeted to supporting our Homebuilding operations, the operating results of our Financial Services operations are highly correlated to Homebuilding. Our Homebuilding customers continue to account for substantially all loan production, representing 99% of loan originations for both 2012 and 2011 and 98% for 2010. We believe that our capture rate, which represents loan originations from our Homebuilding operations as a percentage of total loan opportunities from our Homebuilding operations, excluding cash closings, is an important metric in evaluating the effectiveness of our captive mortgage business model.

The following table presents selected financial information for our Financial Services operations ($000’s omitted):

	Years Ended December 31,
	2012				FY 2011 vs. FY 2010			2011				FY 2011 vs. FY 2010			2010
Mortgage operations revenues	$	137,443			65	%		$	83,260			(12	)%		$	94,587
Title services revenues	23,445				18	%		19,834				(27	)%		27,076
Total Financial Services revenues	160,888				56	%		103,094				(15	)%		121,663
Expenses	135,511				(2	)%		137,666				19	%		116,122
Equity in (earnings) loss of unconsolidated entities	(186		)		82	%		(102		)		50	%		(68		)
Income (loss) before income taxes	$	25,563			174	%		$	(34,470	)		(715	)%		$	5,609
Total originations:
Loans	11,322				19	%		9,482				(12	)%		10,770
Principal	$	2,509,928			26	%		$	1,986,225			(13	)%		$	2,273,394

	Years Ended December 31,
	2012				2011				2010
Supplemental data:
Capture rate	81.9		%		78.5		%		77.5		%
Average FICO score	743				748				749
Loan application backlog	$	1,178,321			$	583,472			$	558,821
Funded origination breakdown:
FHA	25		%		30		%		38		%
VA	12		%		13		%		12		%
Other agency	61		%		56		%		49		%
Total agency	98		%		99		%		99		%
Non-agency	2		%		1		%		1		%
Total funded originations	100		%		100		%		100		%

Revenues

Total Financial Services revenues during 2012 increased 56% compared to 2011 due to a 19% increase in loan origination volumes, an increase in average loan size, and improved loan pricing. The increase in loan origination volumes was due to a higher capture rate, higher Homebuilding closing volumes, and fewer cash sales. Interest income, which is included in mortgage operations revenues, was moderately higher in 2012 than in 2011 due to the increase in loan originations.

Financial Services revenues during 2011 decreased 15% compared with 2010, due in large part to a 12% decrease in loan origination volumes compared to 2010 resulting from lower Homebuilding volumes. Interest income was moderately lower in 2011 than in 2010 due to lower interest rates on loans originated.

In recent years, the mortgage industry has experienced a significant overall tightening of lending standards and a shift toward agency production and fixed rate loans versus adjustable rate mortgages (“ARMs”) and unconventional loans. The substantial majority of loan production during 2012, 2011, and 2010 consisted of fixed rate loans, the majority of which are prime, conforming loans. The shift toward agency fixed-rate loans has contributed to profitability as such loans generally result in higher profitability due to higher servicing values and structured guidelines that allow for expense efficiencies when processing the loan. Additionally, the historically low interest rates and difficult regulatory environment in recent periods has contributed to profitability by reducing the level of pricing competition in the market.

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 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. During 2012, 2011, and 2010, we recorded additional provisions for losses as a change in estimate primarily to reflect projected claim volumes in excess of previous estimates. Losses related to loan origination liabilities totaled $49.0 million, $59.3 million, and $16.9 million in 2012, 2011, and 2010, respectively, and are reflected in Financial Services expenses. Given the volatility in the mortgage industry and the uncertainty regarding the ultimate resolution of these claims, it is reasonably possible that future losses may exceed our current estimates. See our Critical Accounting Policies and Estimates and Note 13 to the Consolidated Financial Statements for additional discussion.

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 14 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. 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, and we are not aware of any current or threatened legal proceedings regarding those transactions.

Income before income taxes

The income before income taxes for 2012 as compared to the loss before income taxes in the prior year period was due to higher origination volumes, improved loan pricing, and lower loss reserves related to loans originated in previous years. Such loss reserves totaled $49.0 million in 2012, compared with $59.3 million in 2011 (see Loan origination liabilities above).

The loss before income taxes in 2011 was due to increased loss reserves related to contingent loan origination liabilities, which totaled $59.3 million in 2011, compared to $16.9 million in 2010 (see Loan origination liabilities above). Excluding these losses, our Financial Services segment experienced higher profitability during 2011 than in 2010, primarily as the result of improved loan pricing.

Income Taxes

Our effective tax rate is affected by a number of factors, the most significant of which are the valuation allowance recorded against our deferred tax assets and changes in our unrecognized tax benefits. Due to the effects of these factors, our effective tax rates for 2010 through 2012 are not correlated to the amount of our income or loss before income taxes. Our effective tax rates were (12.3)%, 32.2%, and 11.2% in 2012, 2011 and 2010, respectively. The income tax benefits for 2012, 2011, and 2010 were primarily due to the favorable resolution of certain federal and state income tax matters.

Liquidity and Capital Resources

We finance our land acquisition, development, and construction activities and financial services operations by using internally-generated funds supplemented by credit arrangements with third parties and capital market financing. We routinely monitor current and expected operational requirements and financial market conditions to evaluate accessing other available financing sources, including revolving bank credit and securities offerings. Based on our current financial condition and credit relationships, we believe that our operations and borrowing resources are sufficient to provide for our current and foreseeable capital requirements. However, we continue to evaluate the impact of market conditions on our liquidity and may determine that modifications are appropriate if market conditions deteriorate, if significant growth returns to the homebuilding industry, or if favorable capital market opportunities become available.

At December 31, 2012, we had unrestricted cash and equivalents of $1.4 billion and senior notes of $2.5 billion. We also had restricted cash balances of $72.0 million, the substantial majority of which related to cash serving as collateral under certain letter of credit facilities. Other financing sources include various letter of credit facilities and surety bond arrangements.

We follow a diversified investment approach for our cash and equivalents by maintaining such funds with a diversified portfolio of banks within our group of relationship banks in high quality, highly liquid, short-term investments, generally money market funds and federal government or agency securities. We monitor our investments with each bank and do not believe our cash and equivalents are exposed to any material risk of loss. However, there can be no assurances that losses of principal balance on our cash and equivalents will not occur.

Our ratio of debt to total capitalization, excluding our Financial Services debt, was 53.4% at December 31, 2012, and 32.1% net of cash and equivalents, including restricted cash. The ratio of debt to total capitalization remains above our desired target. Therefore, we are actively pursuing strategies to reduce our leverage through a combination of cash-generating activities, reducing debt, and returning to consistent profitability. In 2012 this was evidenced by the significant cash flow generated from our operations, primarily through a reduction of inventory, retiring $592.4 million of outstanding debt, and returning our operations to profitability.

Credit agreements

We maintain separate cash-collateralized letter of credit agreements with a number of financial institutions. Letters of credit totaling $54.5 million were outstanding under these agreements at December 31, 2012. Under these agreements, we are required to maintain deposits with these 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 that expires in September 2014. This facility originally permitted the issuance of up to $200.0 million of letters of credit for general corporate purposes in support of any wholly-owned subsidiary. We voluntarily reduced the capacity of this facility to $150.0 million effective July 2, 2012. At December 31, 2012, $124.6 million of letters of credit were outstanding under this facility.

Pulte Mortgage

Pulte Mortgage provides mortgage financing for the majority of our home closings by 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 to third party investors, which generally occurs within 30 days. In September 2012, Pulte Mortgage entered into a Master Repurchase Agreement (the “Repurchase Agreement”) with third party lenders. The Repurchase Agreement provides for loan purchases of up to $150.0 million, subject to certain sublimits, and borrowings under the Repurchase Agreement are secured by residential mortgage loans available-for-sale. At December 31, 2012, Pulte Mortgage had $138.8 million outstanding under the Repurchase Agreement, which expires in September 2013. While there can be no assurances that the Repurchase Agreement can be renewed or replaced on commercially reasonable terms upon its expiration, we believe we have adequate liquidity to meet Pulte Mortgage's anticipated financing needs.

Stock repurchase programs

Pursuant to $100 million stock repurchase programs authorized by our Board of Directors in October 2002 and October 2005, and a $200 million stock repurchase authorization in February 2006 (for a total stock repurchase authorization of $400 million), we have repurchased a total of 9,688,900 shares for a total of $297.7 million. There have been no repurchases under these programs since 2006. We had remaining authorization to purchase common stock aggregating $102.3 million at December 31, 2012.

Dividends

We did not declare a dividend in 2012, 2011, or 2010. Future dividends will depend upon a variety of factors considered relevant by the Board of Directors, including our earnings, capital requirements, financial condition, market conditions, and other factors.

Cash flows

In 2012, we generated significant positive operating cash flow through a combination of earnings and significant reductions in inventory. However, as growth conditions return to the homebuilding industry, we will need to invest significant capital into our operations to support such growth. Additionally, the supply of finished lots (fully developed land) ready for immediate home construction has declined in many of our markets. As a result, we expect that raw or partially developed land and related development costs will represent an increasing proportion of our future land investments, which may result in increased inventory levels.

Operating activities

Our net cash provided by operating activities in 2012 was $760.1 million, compared with $17.3 million and $592.1 million in 2011 and 2010, respectively. Generally, the primary drivers of our cash flow from operations are profitability and changes in inventory levels. Our positive cash flow from operations for 2012 was primarily due to our net income of $206.1 million combined with a net decrease in inventories of $455.2 million. The inventory decrease resulted from lower reinvestment in land inventory combined with a significant reduction in spec homes in production, partially offset by an increase in sold homes in production.

The net losses for 2011 and 2010 were largely the result of non-cash asset impairments and insurance reserve adjustments, so the cash flows from operations each period primarily relate to changes in working capital. Our positive cash flow from operations in 2011 was primarily the result of a net decrease in inventories combined with income tax refunds, net of payments, of $62.2 million offset by financing Pulte Mortgage's lending operations, which reduced cash flows from operations by $52.8 million in 2011.

Our positive cash flow from operations for 2010 was primarily the result of income tax refunds, net of payments, of $941.3 million. After adjusting for these tax refunds, operating cash flow was negative for 2010. Cash flows from operations in 2010 were negatively impacted by the voluntary repurchase of certain community development district obligations for $111.2 million (see above) and using $74.5 million to finance Pulte Mortgage's lending operations. During 2010, inventory levels and residential mortgage loans available-for-sale decreased slightly.

Investing activities

Net cash provided by investing activities totaled $9.7 million in 2012, compared with net cash used in investing activities of $93.6 million in 2011 and $19.5 million in 2010. The positive cash flow from investing activities in 2012 was primarily due to a $28.7 million decrease in the restricted cash we are required to maintain under our letter of credit facilities, which resulted from a reduction in letters of credit outstanding, offset by capital expenditures and investments in unconsolidated entities.

The negative cash flow from investing activities for 2011 was due to $83.2 million of restricted cash we were required to maintain related to our letter of credit facilities, partially offset by proceeds from the sale of property and equipment related to the consolidation of certain facilities.

The net cash used in investing activities in 2010 was primarily the result of investments in unconsolidated entities and capital expenditures, partially offset by distributions from unconsolidated entities and a reduction in residential mortgage loans held for investment.

Financing activities

Net cash used in financing activities was $448.2 million in 2012, compared with $324.0 million and $949.7 million in 2011 and 2010, respectively. During the last three years, we significantly reduced our outstanding senior notes through a variety of transactions, including scheduled maturities, open market repurchases, early redemptions as provided within indenture agreements, and tender offers. Completion of these transactions required the use of $618.8 million, $321.1 million, and $935.9 million of cash in 2012, 2011, and 2010, respectively. Cash used in financing activities in 2012 also reflects $138.8 million of borrowings under the Repurchase Agreement as well as $32.8 million from issuance of common shares in connection with stock option exercises. As discussed above, we used internal funds to finance Pulte Mortgage's operations during 2011 and 2010, the effects of which are reflected in cash flows from operating activities.

Inflation

We, and the homebuilding industry in general, may be adversely affected during periods of high inflation because of higher land and construction costs. Inflation may also increase our financing costs. In addition, higher mortgage interest rates affect the affordability of permanent mortgage financing to prospective homebuyers. While we attempt to pass on to our customers increases in our costs through increased sales prices, market forces may limit our ability to do so. If we are unable to raise sales prices enough to compensate for higher costs, or if mortgage interest rates increase significantly, our revenues, gross margins, and net income would be adversely affected.

Seasonality

Our homebuilding operating cycle historically reflected increased revenues, profitability, and cash flow from operations during the fourth quarter based on the timing of home closings. While the challenging market conditions experienced in recent years lessened the seasonal variations of our results, we have experienced a return to a more traditional demand pattern as new orders were higher in the first half of the year and home closings increased in each quarter throughout the year. If and when the homebuilding industry more fully recovers from the recent downturn, we believe these traditional seasonal patterns will continue.

Contractual Obligations and Commercial Commitments

The following table summarizes our payments under contractual obligations as of December 31, 2012:

	Payments Due by Period ($000’s omitted)
	Total				2013				2014-2015				2016-2017				After 2017
Contractual obligations:
Long-term debt (a)	$	4,536,577			$	161,093			$	1,047,757			$	731,430			$	2,596,297
Operating lease obligations	118,758				29,526				47,970				24,776				16,486
Other long-term liabilities (b)	2,465				1,677				788				—				—
Total contractual obligations (c)	$	4,657,800			$	192,296			$	1,096,515			$	756,206			$	2,612,783

(a)	Represents principal and interest payments related to our senior notes.

(b)	Represents limited recourse collateralized financing arrangements and related interest payments.

(c)	We do not have any payments due in connection with capital lease or long-term purchase obligations.

We are subject to certain obligations associated with entering into contracts (including land option contracts) for the purchase, development, and sale of real estate in the routine conduct of our business. Option contracts for the purchase of land enable us to defer acquiring portions of properties owned by third parties and unconsolidated entities until we have determined whether to exercise our option, which may serve to reduce our financial risks associated with long-term land holdings. At December 31, 2012, we had $70.1 million of deposits and pre-acquisition costs relating to option agreements to acquire 16,815 homesites with a remaining purchase price of $923.4 million. We expect to acquire approximately half of these lots within the next two years and the remainder thereafter.

At December 31, 2012, we had $170.4 million of gross unrecognized tax benefits and $31.5 million of related accrued interest and penalties. We are currently under examination by various taxing jurisdictions and anticipate finalizing the examinations with certain jurisdictions within the next twelve months. However, 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 - 2012.

The following table summarizes our other commercial commitments as of December 31, 2012:

	Amount of Commitment Expiration by Period ($000’s omitted)
	Total				2013				2014-2015				2016-2017				After 2017
Other commercial commitments:
Guarantor credit facilities (a)	$	204,547			$	54,547			$	150,000			$	—			$	—
Non-guarantor credit facilities (b)	150,000				150,000				—				—				—
Total commercial commitments (c)	$	354,547			$	204,547			$	150,000			$	—			$	—

(a)	The $150.0 million in 2014 represents the capacity of our unsecured letter of credit facility, of which $124.6 million was outstanding at December 31, 2012, while the $54.5 million in 2013 represents letters of credit outstanding under our cash-collateralized letter of credit agreements.

(b)	Represents the capacity of the Repurchase Agreement, which expires in September 2013.

(c)	The above table excludes an aggregate $1.0 billion of surety bonds, which typically do not have stated expiration dates.

Off-Balance Sheet Arrangements

We use letters of credit and surety bonds to guarantee our performance under various contracts, principally in connection with the development of our projects. The expiration dates of the letter of credit contracts coincide with the expected completion date of the related homebuilding projects. If the obligations related to a project are ongoing, annual extensions of the letters of credit are typically granted on a year-to-year basis. At December 31, 2012, we had outstanding letters of credit of $179.2 million. Our surety bonds generally do not have stated expiration dates; rather, we are released from the bonds as the contractual performance is completed. These bonds, which approximated $1.0 billion at December 31, 2012, are typically outstanding over a period of approximately three to five years. 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.

In the ordinary course of business, we enter into land option agreements in order to procure land for the construction of houses in the future. At December 31, 2012, these agreements had an aggregate remaining purchase price of $923.4 million. Pursuant to these land option agreements, we provide a deposit to the seller as consideration for the right to purchase land at different times in the future, usually at predetermined prices. In certain instances, we are required to record the land under option as if we own it. At December 31, 2012, we consolidated certain land option agreements and recorded assets of $31.1 million as land, not owned, under option agreements.

At December 31, 2012, aggregate outstanding debt of unconsolidated joint ventures was $6.9 million, of which our proportionate share of such joint venture debt was $1.6 million. Of our proportionate share of joint venture debt, we provided limited recourse guaranties for $0.8 million at December 31, 2012. See Note 6 to the Consolidated Financial Statements for additional information.

Critical Accounting Policies and Estimates

The accompanying consolidated financial statements were prepared in conformity with United States generally accepted accounting principles. When more than one accounting principle, or the method of its application, is generally accepted, we select the principle or method that is appropriate in our specific circumstances (see Note 1 of our Consolidated Financial Statements). Application of these accounting principles requires us to make estimates about the future resolution of existing uncertainties; as a result, actual results could differ from these estimates. In preparing these consolidated financial statements, we have made our best estimates and judgments of the amounts and disclosures included in the consolidated financial statements, giving due regard to materiality.

Revenue recognition

Homebuilding – Homebuilding revenue and related profit are generally recognized at the time of the closing of the sale, when title to and possession of the property are transferred to the buyer. In situations where the buyer’s financing is originated by Pulte Mortgage, our wholly-owned mortgage subsidiary, and the buyer has not made an adequate initial or continuing investment, the profit on such sales is deferred until the sale of the related mortgage loan to a third-party investor has been completed, unless there is a loss on the sale in which case the loss on such sale is recognized at the time of closing.

Financial Services – Mortgage servicing fees represent fees earned for servicing loans for various investors. Servicing fees are based on a contractual percentage of the outstanding principal balance, or a contracted set fee in the case of certain sub-servicing arrangements, and are credited to income when related mortgage payments are received or the sub-servicing fees are earned. Loan origination fees, commitment fees, and certain direct loan origination costs are recognized as incurred. 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. Interest income is accrued from the date a mortgage loan is originated until the loan is sold. Loans are placed on non-accrual status once they become greater than 90 days past due their contractual terms. Subsequent payments received are applied according to the contractual terms of the loan.

Inventory valuation

Inventory is stated at cost unless the carrying value is determined to not be recoverable, in which case the affected inventory is written down to fair value. Cost includes land acquisition, land development, and home construction costs, including interest, real estate taxes, and certain direct and indirect overhead costs related to development and construction. For those communities for which construction and development activities have been idled, applicable interest and real estate taxes are expensed as incurred. Land acquisition and development costs are allocated to individual lots using an average lot cost determined based on the total expected land acquisition and development costs and the total expected home closings for the community. The specific identification method is used to accumulate home construction costs.

We capitalize interest cost into homebuilding inventories. Each layer of capitalized interest is amortized over a period that approximates the average life of communities under development. Interest expense is allocated over the period based on the cyclical timing of home closings.

Cost of revenues includes the construction cost, average lot cost, estimated warranty costs, and commissions and closing costs applicable to the home. The construction cost of the home includes amounts paid through the closing date of the home, plus an appropriate accrual for costs incurred but not yet paid, based on an analysis of budgeted construction costs. This accrual is reviewed for accuracy based on actual payments made after closing compared with the amount accrued, and adjustments are made if needed. Total community land acquisition and development costs are based on an analysis of budgeted costs compared with actual costs incurred to date and estimates to complete. The development cycles for our communities range from under one year to in excess of ten years for certain master planned communities. Adjustments to estimated total land acquisition and development costs for the community affect the amounts costed for the community’s remaining lots.

We record valuation adjustments on land inventory 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. For communities that demonstrate indicators of impairment, we compare the expected undiscounted cash flows for these communities to their carrying value. For those communities whose carrying values exceed the expected undiscounted cash flows, we calculate the fair value of the community. Impairment charges are required to be recorded if the fair value of the community’s inventory is less than its carrying value.

We generally determine the fair value of each community’s inventory using a combination of discounted cash models and market comparable transactions, where available. These estimated cash flows are significantly impacted by estimates related to expected average selling prices and sale incentives, expected sales paces and cancellation rates, expected land development and construction timelines, and anticipated land development, construction, and overhead costs. Such estimates must be made for each individual community and may vary significantly between communities. 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.

Residential mortgage loans available-for-sale

In accordance with ASC 825, “Financial Instruments” (“ASC 825”), we use the fair value option for our residential mortgage loans available-for-sale. Election of the fair value option for residential mortgage loans available-for-sale 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. Changes in the fair value of these loans are reflected in revenues as they occur.

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).

We sell substantially all of the loans we originate to investors in the secondary market within a short period of time after origination. In recent years, we experienced a significant increase in losses 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, generally after a portion of the loan principal had been paid down, which reduces our exposure. 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.

During 2012, 2011, and 2010, we recorded additional provisions for losses as a change in estimate primarily to reflect projected claim volumes in excess of previous estimates. 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, it is reasonably possible that future losses may exceed our current estimates. For example, if the total number of loans we are required to repurchase is ultimately 10% lower or higher than our current estimates, the amount of future losses would decrease or increase by approximately $16.0 million.

Intangible assets

We have recorded intangible assets related to tradenames acquired with the Centex merger completed in 2009 and the Del Webb merger completed in 2001, which are being amortized over their estimated useful lives. The carrying values and ultimate realization of these assets are dependent upon estimates of future earnings and benefits that we expect to generate from their use. If we determine that the carrying values of intangible assets may not be recoverable based upon the existence of one or more indicators of impairment, we use a projected undiscounted cash flow method to determine if impairment exists. If the carrying values of the intangible assets exceed the expected undiscounted cash flows, then we measure impairment as the difference between the fair value of the asset and the recorded carrying value. While the industry downturn in recent years has resulted in a decline in the fair value of these intangible assets, this decline has not yet resulted in an impairment of the assets' carrying values. However, if our expectations of future results and cash flows decrease significantly or if our strategy related to the use of the intangible assets changes, the related intangible assets may be impaired.

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 ten years. We estimate the costs to be incurred under these warranties and record a liability in the amount of such costs at the time product revenue is recognized. Factors that affect our warranty liability include the number of homes sold, historical and anticipated rates of warranty claims, and the cost per claim. We periodically assess the adequacy of our recorded warranty liability for each geographic market in which we operate and adjust the amounts as necessary. Actual warranty costs in the future could differ from our estimates.

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 higher 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 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 relating to legal fees, expert fees, and claims handling expenses) on an undiscounted basis at the time product revenue is recognized for each home closing and evaluate the recorded liabilities based on actuarial analyses of our historical claims. The actuarial analyses calculate an estimate 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 make up 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 our subcontractors or other third parties. Estimates of such amounts are recorded when recovery is considered probable.

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 74% and 78% of the total general liability reserves, which represent the vast majority of the total recorded reserves, at December 31, 2012 and 2011, respectively. 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 estimated reserves are recorded in the period in which the change in estimate occurs. Because the majority of our recorded 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 the 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.

We have experienced a high level of insurance-related expenses in recent years, primarily due to the adverse development of general liability claims, the frequency and severity of which have increased significantly over historical levels. During 2010, we experienced a greater than anticipated frequency of newly reported claims and a significant increase in specific case reserves related to certain known claims. The general nature of these claims was not out of the ordinary, but the frequency and severity of the claims were in excess of our historical experience. As a result of these unfavorable trends, we recorded additional reserves totaling $280.4 million ($0.74 per basic and diluted share) within selling, general, and administrative expenses. Substantially all of this additional reserve related to general liability exposures, a large portion of which resulted from revising our actuarial assumptions surrounding the long-term frequency, severity, and development of claims. During the industry downturn over the last several years, and especially in 2010, we experienced adverse claim frequency and severity compared with longer term averages. In 2010, we deemed it appropriate to assume that the long-term future frequency, severity, and development of claims will most closely resemble the claims activity experienced in recent years.

Our recorded reserves for all such claims totaled $721.3 million and $739.0 million at December 31, 2012 and 2011, respectively, the vast majority of which relate to general liability claims. Because of the inherent uncertainty in estimating future losses related to these claims, actual costs could differ significantly from estimated costs. Based on the actuarial analyses performed, we believe the range of reasonably possible losses related to these claims is $650 million to $800 million. While this range represents our best estimate of our ultimate liability related to these claims, due to a variety of factors, including those factors described above, there can be no assurance that the ultimate costs realized by us will fall within this range.

Income taxes

We follow the provisions of ASC 740, “Income Taxes” (“ASC 740”), which prescribes a minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. ASC 740 also provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, and disclosure. Significant judgment is required to evaluate uncertain tax positions. Evaluations of our tax positions consider changes in facts or circumstances, changes in law, correspondence with taxing authorities, and settlements of audit issues.

We calculate our provision for income taxes using the asset and liability method, under which deferred tax assets and liabilities are recognized by identifying the temporary differences arising from the different treatment of items for tax and accounting purposes. In assessing the realizability of deferred tax assets, we consider whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is primarily dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. In determining the future tax consequences of events that have been recognized in our financial statements or tax returns, judgment is required.

We continue to analyze all available positive and negative evidence in determining the continuing need for a valuation allowance. This evaluation considers, among other factors, historical operating results, forecasts of future profitability, and the duration of statutory carryforward periods. One of the primary pieces of negative evidence we consider is the significant losses we have incurred in recent years, including being in a significant three-year cumulative pre-tax loss position at December 31, 2012. Other negative evidence includes a challenging U.S. macroeconomic environment and uncertainty regarding the timing of a broad, sustainable recovery in the homebuilding industry. However, we earned a profit before income taxes for the year ended December 31, 2012 and have seen significant increases in new orders, backlog, and home sale gross margin. If current business trends continue, including continued improvements in the homebuilding industry, and we continue to be profitable, we believe that there could be sufficient positive evidence to support reducing a large portion of the valuation allowance during

2013. Realization of a portion of our deferred tax assets for state NOL carryforwards and other items, however, is more unlikely than the realization of federal deferred tax assets. This is due to the need to generate sufficient taxable income in each of the respective jurisdictions prior to the expirations of the various state carryforward periods, some of which expire sooner than the 20-year federal NOL carryforwards.

New accounting pronouncements

See Note 1 to the Consolidated Financial Statements.