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

Overview

The overall U.S. housing market continues to be influenced by a combination of low interest rates and affordable home prices that have kept monthly mortgage payments affordable relative to historical levels and the rental market. This environment has contributed to our experiencing relatively stable overall demand in 2014. On slightly lower unit volumes, we generated a 4% increase in home sale revenues to $5.7 billion. We leveraged this growth into a 33% increase in reported pretax income of $635 million for our homebuilding operations by improving gross margins by 280 basis points to 23.3%, amongst the highest annual gross margins reported in the Company's history. Including our Financial Services operations, we realized pretax income growth of 31% to $690 million.

We generated positive cash flow from operations in 2014 due primarily to improved profitability. Our improved financial position provided additional flexibility to retire debt early and increase our investments in future communities, while also returning funds to shareholders through dividends and expanded share repurchases. Specifically, we accomplished the following during 2014:

• Proactively reduced our outstanding debt by $245.7 million;

•	Increased our existing share repurchase authorization by $750.0 million and retired $245.8 million of shares;

•	Raised our quarterly dividend by 60% to $0.08 per share;

•	Increased our land investment spending by almost 40% to support future growth;

•	Lowered our ratio of debt to total capitalization to 27.5%; and

•	Ended the year with a total cash balance of $1.3 billion.

Assuming market conditions remain consistent with our expectations, we also expect to continue to invest increasing amounts into our land portfolio following our disciplined capital allocation process. Our first priority in allocating capital is to invest responsibly in our business and then to return excess funds to shareholders in the form of dividends and share repurchases on a routine and systematic basis. By intelligently investing in our business while routinely returning funds to shareholders, we are aligning our capital allocation decisions with our value creation strategy and our fundamental goal of increasing long-term total shareholder returns.

We are optimistic heading into 2015. We believe the positive factors of an improving economy with declining energy costs, rising employment, lower mortgage rates and related fees, beneficial long-term demographic trends, and a generally healthy supply of inventory will continue to support a slow and sustained housing recovery. Within this environment, we remain focused on driving additional gains in construction and asset efficiency to deliver higher returns on invested capital. Consistent with our positive market view and long-term business strategy, we expect to use our capital to support future growth, while consistently returning funds to shareholders.

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

	Years Ended December 31,
	2014				2013				2012
Income before income taxes:
Homebuilding	$	635,177			$	479,113			$	157,991
Financial Services	54,581				48,709				25,563
Income before income taxes	689,758				527,822				183,554
Income tax expense (benefit)	215,420				(2,092,294		)		(22,591		)
Net income	$	474,338			$	2,620,116			$	206,145
Per share data - assuming dilution:
Net income	$	1.26			$	6.72			$	0.54

•	Homebuilding income before income taxes improved each year from 2012 to 2014, primarily as the result of higher gross margins and revenues. Homebuilding income before income taxes also reflected the following significant items ($000's omitted):

	2014				2013				2012
Land-related charges (see Note 3)	$	11,168			$	9,672			$	17,195
Loss on debt retirements (see Note 6)	8,584				26,930				32,071
Settlement of contractual dispute at a closed-out community (see Note 12)	—				41,170				—
Corporate office relocation (see Note 2)	16,344				15,376				—
Insurance reserve adjustments (see Note 12)	69,267				—				—
	$	105,363			$	93,148			$	49,266

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

The acquisition of certain real estate assets from Dominion Homes in August 2014 (see Note 1) was not material to our results of operations or financial condition.

•

The increase in Financial Services income in 2014 compared with 2013 and 2012 was primarily due to lower provisions for loan losses. We reduced loss reserves by $18.6 million in 2014 while there were no adjustments to the reserve in 2013. In 2012, loss reserves increased by $49.0 million. See Note 12 to the Consolidated Financial Statements. Excluding these loss reserve adjustments, Financial Services income has been declining since 2012 due to margin compression caused by heightened competition in the mortgage industry.

•

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 in tax laws or other circumstances that impact the value of our deferred tax assets, and changes in our unrecognized tax benefits. Due to the effects of these factors, our effective tax rates in 2014, 2013, and 2012 are not correlated to the amount of our income before income taxes. Income tax expense (benefit) reflects reversals of deferred tax asset valuation allowances totaling $45.6 million in 2014 and $2.1 billion in 2013. The income tax benefit in 2012 was attributable primarily to the favorable resolution of certain federal and state income tax matters. See Note 9 to the Consolidated Financial Statements for additional information.

Homebuilding Operations

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

	Years Ended December 31,
	2014				FY 2014 vs. FY 2013			2013				FY 2013 vs. FY 2012			2012
Home sale revenues	$	5,662,171			4	%		$	5,424,309			19	%		$	4,552,412
Land sale revenues	34,554				(70	)%		114,335				7	%		106,698
Total Homebuilding revenues	5,696,725				3	%		5,538,644				19	%		4,659,110
Home sale cost of revenues (a)	4,343,249				1	%		4,310,528				12	%		3,833,451
Land sale cost of revenues	23,748				(77	)%		104,426				10	%		94,880
Selling, general, and administrative expenses ("SG&A") (b)	667,815				17	%		568,500				11	%		514,457
Equity in earnings of unconsolidated entities	(8,226		)		728	%		(993		)		(74	)%		(3,873		)
Other expense, net (c)	38,745				(52	)%		80,753				22	%		66,298
Interest income, net	(3,783		)		3	%		(3,683		)		(10	)%		(4,094		)
Income before income taxes	$	635,177			33	%		$	479,113			(203	)%		$	157,991
Supplemental data:
Gross margin from home sales	23.3		%		280 bps			20.5		%		470 bps			15.8		%
SG&A as a percentage of home sale revenues	11.8		%		130 bps			10.5		%		(80) bps			11.3		%
Closings (units)	17,196				(3	)%		17,766				8	%		16,505
Average selling price	$	329			8	%		$	305			11	%		$	276
Net new orders:
Units	16,652				(3	)%		17,080				(10	)%		19,039
Dollars (d)	$	5,558,937			3	%		$	5,394,566			(1	)%		$	5,424,300
Cancellation rate	15		%					15		%					15		%
Active communities at December 31	598				4	%		577				(14	)%		670
Backlog at December 31:
Units	5,850				1	%		5,772				(11	)%		6,458
Dollars	$	1,943,861			2	%		$	1,901,796			(2	)%		$	1,931,538

(a)	Includes the amortization of capitalized interest. Home sale cost of revenues also includes land impairments of $3.9 million, $2.9 million, and $13.4 million for 2014, 2013, and 2012, respectively.

(b)	SG&A includes costs associated with the relocation of our corporate headquarters totaling $7.6 million and $15.0 million in 2014 and 2013, respectively, and charges totaling $69.3 million to increase general liability insurance reserves in 2014.

(c)

Includes the write-off of deposits and pre-acquisition costs for land option contracts we elected not to pursue of $6.1 million, $3.1 million, and $2.3 million in 2014, 2013, and 2012, respectively, and net losses related to the redemption of debt totaling $8.6 million, $26.9 million, and $32.1 million in 2014, 2013, and 2012, respectively. Also includes lease exit charges of $8.7 million in 2014 resulting from the relocation of our corporate headquarters and charges totaling $41.2 million in 2013 resulting from a contractual dispute related to a previously completed luxury community.

(d)	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 2014 were higher than 2013 by $237.9 million, or 4%. The increase was attributable to an 8% increase in the average selling price partially offset by a 3% decrease in closings. The increase in average selling price occurred in substantially all of our local markets and reflects an ongoing shift in our revenue mix toward move-up and active adult buyers along with improved market conditions that have allowed for increased sale prices, including higher levels of house options and lot premiums. The decrease in closings resulted from the lower net new order volume in 2014 combined with the lower beginning of the year backlog in 2014 compared with the beginning of the year 2013. The nature of the homebuilding industry results in a lag between when the significant investments we have made in land acquisition and development the last two years yields new community openings and related home closings.

Home sale revenues for 2013 were higher than 2012 by $871.9 million, or 19%. The increase was attributable to an 11% increase in the average selling price combined with an 8% increase in closings. The increase in average selling price occurred in substantially all of our local markets and reflects an ongoing shift in our revenue mix toward move-up and active adult buyers and improved market conditions that have allowed for increased sale prices, including higher levels of house options and lot premiums. The increase in closings reflected improved consumer demand for new homes in the majority of our local markets.

Home sale gross margins

Home sale gross margins were 23.3% in 2014, compared with 20.5% in 2013 and 15.8% in 2012. The gross margin improvement was broad-based as substantially all of our operating divisions experienced higher gross margins in 2014 compared with the prior year periods. These improved gross margins reflect a combination of factors, including an improved pricing environment, contributions from our strategic pricing and house cost reduction initiatives, and lower amortized interest costs (3.4%, 4.7%, and 4.9% in 2014, 2013, and 2012, respectively). The lower amortized interest costs resulted from a significant reduction in our outstanding debt in recent years. Gross margins during 2014 and 2013 also benefited from lower land impairments of $3.9 million and $2.9 million, respectively, compared with $13.4 million in 2012.

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 $10.8 million, $9.9 million, and $11.8 million in 2014, 2013, and 2012, respectively.

SG&A

SG&A as a percentage of home sale revenues was 11.8% in 2014 compared with 10.5% in 2013 and 11.3% in 2012. The gross dollar amount of our SG&A increased $99.3 million, or 17%, in 2014 compared with 2013. SG&A includes charges totaling $69.3 million to increase general liability insurance reserves in 2014. Additionally, we incurred $7.6 million and $15.0 million in 2014 and 2013, respectively, of employee severance, retention, relocation, and related costs attributable to the relocation of our corporate headquarters. The remaining increases in gross overhead dollars in 2014 compared with 2013 were primarily due to variable costs related to the higher revenue volume.

The gross dollar amount of our SG&A increased $54.0 million, or 11%, in 2013 compared with 2012. In 2013, SG&A includes costs associated with the relocation of our corporate headquarters totaling $15.0 million. The remainder of the increase is due to variable costs related to the higher revenue volume combined with higher incentive compensation accruals resulting from our improved operating results.

Equity in earnings of unconsolidated entities

Equity in earnings of unconsolidated entities was $8.2 million, $1.0 million, and $3.9 million for 2014, 2013, and 2012, respectively. The majority of our unconsolidated entities represent land development joint ventures. Consequently, their results vary between periods depending on the timing of transactions and circumstances specific to each entity.

Other expense, net

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

	2014				2013				2012
Write-offs of deposits and pre-acquisition costs (Note 3)	$	6,099			$	3,122			$	2,278
Loss on debt retirements (Note 6)	8,584				26,930				32,071
Lease exit and related costs	9,609				2,778				7,306
Amortization of intangible assets (Note 1)	13,033				13,100				13,100
Miscellaneous expense, net	1,420				34,823				11,543
	$	38,745			$	80,753			$	66,298

For additional information on each of the above, see the applicable Notes to the Consolidated Financial Statements. Miscellaneous expense, net includes charges of $41.2 million in 2013 resulting from a contractual dispute related to a previously completed luxury community and $5.1 million in 2012 related to the write-down of notes receivable.

Interest income, net

Interest income, net was similar in 2014, 2013, and 2012 based on our invested cash balances and low returns on invested cash available in the current interest rate environment.

Net new orders

Net new orders decreased 3% in 2014 compared with 2013. The number of active communities increased slightly (up 4% to 598 at December 31, 2014) in 2014 versus 2013, though this was primarily due to our acquisition of certain real estate assets from Dominion Homes in August 2014 (see Note 1 to the Consolidated Financial Statements). Excluding such assets, our active community count actually declined in 2014 as our pace of new community openings lagged the number of community close-outs. The cancellation rate (canceled orders for the period divided by gross new orders for the period) was unchanged from 2013 to 2014 at 15%. Ending backlog units, which represent orders for homes that have not yet closed, increased 1% at December 31, 2014 compared with December 31, 2013 as measured in units and increased by 2% over the prior year period as measured in dollars due to the increase in our average selling price.

Net new order levels decreased 10% in 2013 compared with 2012 primarily due to selling from 14% fewer active communities in 2013 (577 active communities at December 31, 2013). The cancellation rate was unchanged from 2012 to 2013 at 15%. Ending backlog units decreased 11% at December 31, 2013 compared with December 31, 2012 due to the decrease in net new orders but only decreased by 2% over the prior period as measured in dollars due to the increase in our average selling price.

Homes in production

The following is a summary of our homes in production at December 31, 2014 and 2013:

		2014			2013
Sold		3,761			3,723
Unsold
Under construction		815			813
Completed		483			338
		1,298			1,151
Models		981			1,034
Total		6,040			5,908

The number of homes in production at December 31, 2014 was essentially flat (2% higher) compared to December 31, 2013. As part of our inventory management strategies, we will continue to maintain reasonable inventory levels relative to demand in each of our markets. Aggressively controlling the start of construction homes unsold to customers ("spec homes") is a component of our strategic pricing and inventory turns objectives. We continue to focus on maintaining a low level of spec home inventory, especially our completed specs ("final specs"), though inventory levels tend to fluctuate throughout the year.

Controlled lots

The following is a summary of our lots under control at December 31, 2014 and 2013:

		December 31, 2014									December 31, 2013
		Owned			Optioned			Controlled			Owned			Optioned			Controlled
Northeast		6,389			4,185			10,574			7,423			2,762			10,185
Southeast		11,195			4,785			15,980			12,702			4,296			16,998
Florida		20,511			7,119			27,630			21,805			6,956			28,761
Texas		11,847			7,435			19,282			12,038			3,860			15,898
North		17,865			8,358			26,223			11,785			7,952			19,737
Southwest		28,413			2,691			31,104			29,459			2,440			31,899
Total		96,220			34,573			130,793			95,212			28,266			123,478
Developed (%)		25	%		23	%		25	%		24	%		18	%		23	%

Of our controlled lots, 96,220 and 95,212 were owned and 34,573 and 28,266 were under land option agreements at December 31, 2014 and 2013, respectively. While competition for well-positioned land is robust, we continue to pursue strategic land positions that meet our underwriting requirements. The remaining purchase price under our land option agreements totaled $1.9 billion at December 31, 2014. 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 $127.3 million, of which only $7.7 million is refundable.

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, 2014, we conducted our operations in 49 markets located throughout 26 states. 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, 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.

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

	Operating Data by Segment ($000's omitted)
	Years Ended December 31,
	2014				FY 2014 vs. FY 2013			2013				FY 2013 vs. FY 2012			2012
Home sale revenues:
Northeast	$	708,465			(10	)%		$	784,087			8	%		$	722,691
Southeast	949,134				13	%		842,856				22	%		689,163
Florida	913,758				14	%		800,331				29	%		620,156
Texas	856,613				6	%		804,806				21	%		666,759
North	1,428,461				18	%		1,214,332				23	%		989,510
Southwest	805,740				(18	)%		977,898				13	%		864,133
	$	5,662,171			4	%		$	5,424,309			19	%		$	4,552,412
Income before income taxes:
Northeast	$	103,865			(6	)%		$	110,246			50	%		$	73,345
Southeast	156,513				29	%		121,055				87	%		64,678
Florida	190,441				36	%		139,673				90	%		73,472
Texas	133,005				19	%		111,431				83	%		60,979
North	197,230				20	%		164,348				94	%		84,597
Southwest	136,357				(24	)%		179,163				124	%		79,887
Other homebuilding (a)	(282,234		)		19	%		(346,803		)		(24	)%		(278,967		)
	$	635,177			33	%		$	479,113			203	%		$	157,991
Closings (units):
Northeast	1,568				(15	)%		1,835				2	%		1,800
Southeast	3,160				5	%		3,022				10	%		2,757
Florida	2,752				—	%		2,747				17	%		2,340
Texas	3,750				—	%		3,768				8	%		3,487
North	3,684				8	%		3,401				10	%		3,103
Southwest	2,282				(24	)%		2,993				(1	)%		3,018
	17,196				(3	)%		$	17,766			8	%		16,505
Average selling price:
Northeast	$	452			6	%		$	427			6	%		$	401
Southeast	300				8	%		279				12	%		250
Florida	332				14	%		291				10	%		265
Texas	228				7	%		214				12	%		191
North	388				9	%		357				12	%		319
Southwest	353				8	%		327				14	%		286
	$	329			8	%		$	305			11	%		$	276

(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 the following: losses on debt retirements of $8.6 million, $26.9 million, and $32.1 million, for 2014, 2013, and 2012, respectively; charges totaling $69.3 million to increase general liability insurance reserves in 2014; costs associated with the relocation of our corporate headquarters totaling $16.3 million and $15.4 million in 2014 and 2013, respectively; and charges of $41.2 million in 2013 resulting from a contractual dispute related to a previously completed luxury community.

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

		Operating Data by Segment ($000's omitted)
		Years Ended December 31,
		2014				FY 2014 vs. FY 2013			2013				FY 2013 vs. FY 2012			2012
Net new orders - units:
Northeast		1,408				(23	)%		1,834				(8	)%		1,997
Southeast		3,075				(3	)%		3,164				3	%		3,066
Florida		2,841				9	%		2,595				(6	)%		2,747
Texas		3,773				6	%		3,563				(13	)%		4,117
North		3,311				(1	)%		3,347				(9	)%		3,661
Southwest		2,244				(13	)%		2,577				(25	)%		3,451
		16,652				(3	)%		17,080				(10	)%		19,039
Net new orders - dollars:
Northeast		$	649,202			(17	)%		$	782,474			(5	)%		$	820,609
Southeast		944,567				5	%		895,800				14	%		787,286
Florida		954,892				16	%		820,032				12	%		735,250
Texas		881,843				11	%		796,377				(1	)%		807,455
North		1,336,114				8	%		1,233,071				—	%		1,228,743
Southwest		792,319				(9	)%		866,812				(17	)%		1,044,957
		$	5,558,937			3	%		$	5,394,566			(1	)%		$	5,424,300
Cancellation rates:
Northeast		12		%					13		%					12		%
Southeast		12		%					12		%					13		%
Florida		10		%					13		%					12		%
Texas		19		%					22		%					22		%
North		13		%					11		%					13		%
Southwest		20		%					19		%					15		%
		15		%					15		%					15		%
Unit backlog:
Northeast		461				(26	)%		621				—	%		622
Southeast		968				(8	)%		1,053				16	%		911
Florida		1,002				10	%		913				(14	)%		1,065
Texas		1,273				2	%		1,250				(14	)%		1,455
North		1,462				21	%		1,213				(4	)%		1,267
Southwest		684				(5	)%		722				(37	)%		1,138
		5,850				1	%		5,772				(11	)%		6,458
Backlog dollars:
Northeast		$	215,977			(22	)%		$	275,239			(1	)%		$	276,851
Southeast		301,033				(1	)%		305,600				21	%		252,656
Florida		349,968				13	%		308,834				7	%		289,133
Texas		311,424				9	%		286,195				(3	)%		294,623
North		518,431				11	%		465,480				4	%		446,741
Southwest		247,028				(5	)%		260,448				(30	)%		371,534
		$	1,943,861			2	%		$	1,901,796			(2	)%		$	1,931,538

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

		Operating Data by Segment ($000's omitted)
		Years Ended December 31,
		2014				FY 2014 vs. FY 2013			2013				FY 2013 vs. FY 2012			2012
Land-related charges*:
Northeast		$	2,824			407	%		$	557			(69	)%		$	1,794
Southeast		1,826				83	%		998				(27	)%		1,363
Florida		487				(55	)%		1,076				403	%		214
Texas		321				68	%		191				(66	)%		556
North		3,227				(6	)%		3,434				(24	)%		4,546
Southwest		816				73	%		472				(79	)%		2,254
Other homebuilding		1,667				(43	)%		2,944				(54	)%		6,468
		$	11,168			15	%		$	9,672			(44	)%		$	17,195

*	Land-related charges include land impairments, net realizable value adjustments for land held for sale, and write-offs of deposits and pre-acquisition costs. Other homebuilding consists primarily of write-offs of capitalized interest resulting from land-related charges. See Notes 3 and 4 to the Consolidated Financial Statements for additional discussion of these charges.

Northeast:

For 2014, Northeast home sale revenues decreased 10% compared with 2013 due to a 15% decrease in closings offset by a 6% increase in the average selling price. The decrease in closings occurred across all divisions. The increase in average selling price occurred primarily in the New England and the Mid-Atlantic. The decreased income before income taxes resulted from lower gross margins and increased overhead. Net new orders decreased 23%, reflecting lower order levels across all divisions due in part to a lower active community count.

For 2013, Northeast home sale revenues increased 8% compared with 2012 due to a 6% increase in the average selling price, combined with a 2% increase in closings. The increase in average selling price occurred primarily in New England and Mid-Atlantic. The increased income before income taxes was due to higher revenues and improved gross margins and overhead leverage. Net new orders decreased 8%, mainly due to lower order levels in the Mid-Atlantic due to fewer active communities, offset in part by an increase in orders in New England.

Southeast:

For 2014, Southeast home sale revenues increased 13% compared with 2013 due to an 8% increase in the average selling price combined with a 5% increase in closings. The increase in average selling price was due to increases across all divisions. The increase in closing volumes was primarily due to increases in Georgia and the Coastal Carolinas. The increased income before income taxes resulted from the higher revenues combined with improved gross margins. Net new orders decreased 3% in 2014 mainly due to lower order levels in Tennessee, Charlotte, and the Coastal Carolinas.

For 2013, Southeast home sale revenues increased 22% compared with 2012 due to a 12% increase in the average selling price, combined with a 10% increase in closings. The increase in average selling price was concentrated in Raleigh and Tennessee. The increase in closing volumes was primarily due to increases in Charlotte and Raleigh. The increased income before income taxes was due to the higher revenues and moderately improved gross margins. Net new orders increased 3% in 2013 led by our operations in Raleigh.

Florida:

For 2014, Florida home sale revenues increased 14% compared with 2013 due to a 14% increase in the average selling price. The increase in average selling price occurred in both North and South Florida. Closings remained flat compared with the prior year as the increase in closings in South Florida was offset by a decrease in closings in North Florida. The increased income before income taxes for 2014 resulted from the higher revenues combined with improved gross margins. Net new orders increased by 9% in 2014 due to an increase in active communities in South Florida.

For 2013, Florida home sale revenues increased 29% compared with 2012 due to a 10% increase in the average selling price and a 17% increase in closings. The increase in closings was concentrated in North Florida while the increase in average selling price occurred in both North and South Florida. The increased income before income taxes for 2013 resulted from the higher revenues combined with improved gross margins and overhead leverage. Net new orders decreased by 6% in 2013 due to fewer active communities in North Florida.

Texas:

For 2014, Texas home sale revenues increased 6% compared with the prior year period due to a 7% increase in average selling price. The increase in average selling price was led by our operations in Central Texas and San Antonio. Closings were consistent with the prior year as the increases in Dallas, Houston, and San Antonio were offset by a decrease in closings in Central Texas. The increased income before income taxes for 2014 resulted from the higher revenues combined with improved gross margins. Net new orders increased by 6% for 2014 while the number of active communities remained consistent with the prior year.

For 2013, Texas home sale revenues increased 21% compared with the prior year period due to an 8% increase in closings combined with a 12% increase in average selling price. The increase in closings was most significant in Houston and Central Texas, while the increase in average selling price was led by our operations in Central Texas and Dallas. The increased income before income taxes for 2013 resulted from the higher revenues combined with improved gross margins and overhead leverage. Net new orders decreased by 13% for 2013 driven mainly by fewer active communities.

North:

For 2014, North home sale revenues increased 18% compared with the prior year period due to an 8% increase in closings and a 9% increase in average selling price. The increase in average selling price was due to increases across all divisions. The increase in closing volumes was primarily due to significant increases in the Midwest, including a small increase from the acquisition of certain real estate assets from Dominion Homes in August 2014, but offset by decreases in other North divisions. Demand in Northern California in particular has slowed in 2014 compared to 2013. The increase in income before income taxes resulted from the higher revenues combined with improved gross margins in the majority of divisions. Net new orders decreased by 1% in 2014 compared with 2013, mainly due to decreases in Illinois, St. Louis, Minnesota, and the Pacific Northwest, partially offset by increases in other North divisions.

For 2013, North home sale revenues increased 23% compared with the prior year period due to a 10% increase in closings and a 12% increase in average selling price. The increase in closing volumes was primarily due to significant increases in Michigan and Northern California. The increase in average selling price was due to increases across all divisions. The increase in income before income taxes resulted from the higher revenues combined with improved gross margins in every division. Net new orders decreased by 9% in 2013 compared with 2012, mainly due to a decrease in Northern California, as we purposely slowed sales pace in a number of communities by raising prices and limiting lot releases.

Southwest:

For 2014, Southwest home sale revenues decreased 18% compared with the prior year period due to a 24% decrease in closings offset in part by an 8% increase in average selling price. Both the decrease in closings and the increase in average selling price occurred across all divisions. The decrease in income before income taxes resulted from lower revenues combined with lower gross margins. Net new orders decreased by 13% in 2014 compared with 2013 primarily due to fewer active communities.

For 2013, Southwest home sale revenues increased 13% compared with the prior year period due to a 14% increase in average selling price offset by a 1% decrease in closings. The increase in average selling price occurred across all divisions. The decrease in closings was mainly due to decreases in Southern California and Las Vegas. The significant increase in income before income taxes was due to higher revenues and gross margins. Net new orders decreased by 25% in 2013 compared with 2012 primarily due to fewer active communities.

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 also 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 business levels of our Financial Services operations are highly correlated to Homebuilding. Our Homebuilding customers continue to account for substantially all loan production. 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,
	2014				FY 2014 vs. FY 2013			2013				FY 2013 vs. FY 2012			2012
Mortgage operations revenues	$	97,787			(14	)%		$	113,552			(17	)%		$	137,443
Title services revenues	27,851				2	%		27,399				17	%		23,445
Total Financial Services revenues	125,638				(11	)%		140,951				(12	)%		160,888
Expenses	71,239				(23	)%		92,379				(32	)%		135,511
Equity in earnings of unconsolidated entities	(182		)		33	%		(137		)		(26	)%		(186		)
Income before income taxes	$	54,581			12	%		$	48,709			91	%		$	25,563
Total originations:
Loans	10,805				(9	)%		11,818				4	%		11,322
Principal	$	2,656,683			(4	)%		$	2,765,509			10	%		$	2,509,928

	Years Ended December 31,
	2014				2013				2012
Supplemental data:
Capture rate	80.2		%		80.2		%		81.9		%
Average FICO score	749				746				743
Loan application backlog	$	980,863			$	984,754			$	1,178,321
Funded origination breakdown:
FHA	10		%		16		%		22		%
VA	12		%		11		%		12		%
USDA	2		%		3		%		3		%
Other agency	70		%		67		%		61		%
Total agency	94		%		97		%		98		%
Non-agency	6		%		3		%		2		%
Total funded originations	100		%		100		%		100		%

Revenues

Total Financial Services revenues during 2014 decreased 11% compared with 2013. The decrease was primarily attributable to lower origination volume resulting from lower home closings in our Homebuilding operations combined with lower revenues per loan resulting from the increased competitiveness in the mortgage industry that began in 2013.

Total Financial Services revenues during 2013 decreased 12% compared with 2012. The decrease was primarily due to lower revenues per loan resulting from the increased competitiveness in the mortgage industry that occurred in 2013. The decline in revenues per loan more than offset the higher origination volume. Interest income, which is included in mortgage operations revenues, was moderately higher in 2013 than in 2012 due to the increase in loan originations.

In recent years, the mortgage industry has experienced a significant overall tightening of lending standards and a shift toward agency production. Adjustable rate mortgages (“ARMs”) accounted for 11% of funded loan production in 2014 compared with 5% and 3% in 2013 and 2012, respectively. The shift toward ARMs has contributed to lower profitability as ARMs generally contain lower margins. Additionally, fixed rate mortgages tend to have higher servicing values. Beginning in 2013, competition increased in the industry, partially as the result of the mortgage industry's lower refinancing volume. We expect this increased level of competition, and more challenging pricing environment, to continue for the foreseeable future.

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 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 at fault, we either repurchase the loans from the investors or reimburse the investors' losses (a “make-whole” payment).

During 2014, we reduced our loan origination liabilities by $18.6 million based on settlements of various pending repurchase requests and current conditions. During 2012, we recorded $49.0 million of provisions for losses as a change in estimate primarily to reflect projected claim volumes in excess of previous estimates. Reserves provided and related adjustments are reflected in Financial Services expenses. 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. See Note 12 in the Consolidated Financial Statements.

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. See Note 12 in the Consolidated Financial Statements.

Income before income taxes

The increased income before income taxes for 2014 as compared with 2013 resulted from lower loss reserves related to loans originated in previous years, partially offset by less favorable loan pricing.

The increased income before income taxes for 2013 as compared with 2012 was due to higher origination volumes and lower loss reserves related to loans originated in previous years, partially offset by less favorable loan pricing.

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 in tax laws or other circumstances that impact the value of our deferred tax assets, and changes in our unrecognized tax benefits. Due to the effects of these factors, our effective tax rates in 2014, 2013, and 2012 are not correlated to the amount of our income before income taxes. Income tax expense for 2014 reflects a reversal of a portion of our valuation allowance, primarily related to certain of our state deferred tax assets, along with the favorable resolution of certain federal and state income tax matters. The income tax benefit for 2013 resulted from the reversal of substantially all of the valuation allowance related to our federal deferred tax assets and certain of our state deferred tax assets, while the income tax benefit for 2012 resulted primarily from the favorable resolution of certain federal and state income tax matters.

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.

Our income tax expense (benefit) for 2014 and 2013 included benefits of $45.6 million and $2.1 billion, respectively, related to reversals of valuation allowance previously recorded against our deferred tax assets. The 2014 reversal related primarily to certain of our state deferred tax assets as the result of an increase in expected future taxable income in certain jurisdictions. In 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. The principal positive evidence that led to the reversal of the valuation allowance in 2013 included: (1) our emergence from a three-year cumulative loss in 2013; (2) the significant positive income we generated during 2012 and 2013, including seven consecutive quarters of pretax income as of December 31, 2013; (3) continued improvements in 2013 over recent years in other key operating metrics, including revenues, gross margin, and overhead leverage; (4) our forecasted future profitability; (5) improvement in our financial position; and (6) significant evidence that conditions in the U.S. housing industry are more favorable than in recent years and our belief that conditions will continue to be favorable over the long-term.

After careful evaluation of all available positive and negative evidence, and giving more weight to objectively verifiable evidence over more subjective evidence, we concluded as of December 31, 2014 and December 31, 2013, that it was "more likely than not" that substantially all of our federal deferred tax assets and a significant portion of our state deferred tax assets would be realized. Even if industry conditions weaken from current levels, we believe we will be able to adjust our operations to sustain long-term profitability.

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.

At December 31, 2014, we had unrestricted cash and equivalents of $1.3 billion and senior notes of $1.8 billion. We also had restricted cash balances of $16.4 million. Other financing sources include an unsecured revolving credit facility, a separate letter of credit agreement, 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, including 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 27.5% at December 31, 2014.

During 2014, we retired prior to their scheduled maturity dates $245.7 million of senior notes. We recorded losses related to these transactions totaling $8.6 million. Losses on these transactions included the write-off of unamortized discounts, premiums, and transaction fees and are reflected in other expense, net. During 2013 and 2012, we retired senior notes totaling $461.4 million and $592.4 million, respectively.

Revolving credit facility

In July 2014, we entered into a senior unsecured revolving credit facility (the “Revolving Credit Facility”) maturing in July 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. At December 31, 2014, we had no borrowings outstanding and $208.4 million of letters of credit issued under the Revolving Credit Facility.

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 December 31, 2014, we were in compliance with all covenants. Outstanding balances under the Revolving Credit Facility are guaranteed by certain of our wholly-owned subsidiaries.

Limited recourse notes payable

We maintain limited recourse collateralized notes payable with third parties totaling $22.3 million and $7.5 million at December 31, 2014 and 2013, respectively. These notes have maturities ranging up to 6 years, are collateralized by the applicable land positions to which they relate, have no recourse to any other assets, and are classified within Accrued and other liabilities.

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 in the secondary market, which generally occurs within 30 days.

Pulte Mortgage maintains a master repurchase agreement (the “Repurchase Agreement”) with third party lenders. In September 2014, Pulte Mortgage entered into an amendment to the Repurchase Agreement that extended the effective date to September 2015 and established a borrowing capacity of $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 $140.2 million and $105.7 million outstanding under the Repurchase Agreement at December 31, 2014, and 2013, respectively, and was in compliance with all of its covenants and requirements.

Stock repurchase programs

In previous years, our Board of Directors authorized and announced a share repurchase program. In October 2014, our Board of Directors approved an increase of $750.0 million to such authorization. We repurchased 12.9 million and 7.2 million shares under the repurchase authorization for a total of $245.8 million and $118.1 million in 2014 and 2013, respectively. There were no repurchases under these programs during 2012. At December 31, 2014, we had remaining authorization to repurchase $738.5 million of common shares.

Dividends

We reinstated our quarterly cash dividend in July 2013. During 2013, we declared three cash dividends of $0.05 per common share each. During 2014, we declared cash dividends of $0.05 per common share in each of the first three quarters and $0.08 per common share in the fourth quarter for a total of $86.4 million.

Cash flows

Operating activities

Our net cash provided by operating activities in 2014 was $309.2 million, compared with $881.1 million and $760.1 million in 2013 and 2012, 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 2014 was primarily due to our income before income taxes of $689.8 million. These cash flows were partially offset in 2014 by a net increase in inventories of $346.6 million as the result of an almost 40% increase in investment spending over the prior year to support future operations. Additionally, residential mortgage loans available-for-sale increased $53.7 million as the result of an increase in home closings in the month of December compared with the prior year.

Our positive cash flow from operations for 2013 was primarily due to our income before income taxes of $527.8 million combined with a net decrease in inventories of $265.1 million and a reduction of $28.4 million in residential mortgage loans available-for-sale. The inventory decrease resulted from a reduction in homes in production and lower land inventory consistent with the decline in the number of our active communities while the decrease in residential mortgage loans available-for-sale resulted from a decrease in the home closings in the month of December compared with the prior year.

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.

Investing activities

Investing activities are generally not a significant source or use of cash for us. Net cash used in investing activities totaled $67.6 million in 2014, compared with $46.0 million in 2013 and net cash provided by investing activities of $9.7 million in 2012. The use of cash from investing activities in 2014 was primarily due to the acquisition of certain real estate assets from Dominion Homes (see Note 1). Additionally, capital expenditures increased in 2014 as the result of new community openings and the relocation of our corporate headquarters. These cash outflows were partially offset by a $55.0 million reduction in restricted cash related to letters of credit as a result of the Revolving Credit Facility entered into in July 2014.

The use of cash from investing activities in 2013 was primarily due to $28.9 million of capital expenditures, a $12.3 million increase in residential mortgage loans held for investment, and a $4.2 million increase in the restricted cash we were required to maintain under our letter of credit facilities.

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.

Financing activities

Net cash used in financing activities was $529.1 million in 2014, compared with net cash used of $659.6 million and $448.2 million in 2013 and 2012, 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 $250.6 million, $479.8 million, and $618.8 million of cash in 2014, 2013, and 2012, respectively. We borrowed an incremental $34.6 million under the Repurchase Agreement during 2014, repaid $33.1 million of borrowings in 2013, and borrowed $138.8 million in 2012, the year in which it was put in place. Cash used in financing activities for 2014 also reflects dividend payments of $75.6 million and the repurchase of common shares for $253.0 million, partially offset by funds provided by the issuance of common shares in connection with employee stock option exercises.

Inflation

We, and the homebuilding industry in general, may be adversely affected during periods of 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 our products 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 could be adversely affected.

Seasonality

Although significant changes in market conditions have impacted our seasonal patterns in the past and could do so again, we historically experience variability in our quarterly results from operations due to the seasonal nature of the homebuilding industry. We generally experience increases in revenues and cash flow from operations during the fourth quarter based on the timing of home closings. This seasonal activity increases our working capital requirements in our third and fourth quarters to support our home production and loan origination volumes. As a result of the seasonality of our operations, our quarterly results of operations are not necessarily indicative of the results that may be expected for the full year.

Contractual Obligations and Commercial Commitments

The following table summarizes our payments under contractual obligations as of December 31, 2014:

	Payments Due by Period ($000’s omitted)
	Total				2015				2016-2017				2018-2019				After 2019
Contractual obligations:
Long-term debt (a)	$	3,160,188			$	350,986			$	756,375			$	134,252			$	1,918,575
Operating lease obligations	143,723				28,744				44,530				27,716				42,733
Other long-term liabilities (b)	26,844				1,210				15,518				5,046				5,070
Total contractual obligations (c)	$	3,330,755			$	380,940			$	816,423			$	167,014			$	1,966,378

(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, 2014, we had $127.3 million of deposits and pre-acquisition costs relating to option agreements to acquire 34,573 lots with a remaining purchase price of $1.9 billion. We expect to acquire the majority of such land within the next two years and the remainder thereafter.

At December 31, 2014, we had $32.9 million of gross unrecognized tax benefits and $17.3 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 2004 - 2014.

The following table summarizes our other commercial commitments as of December 31, 2014:

	Amount of Commitment Expiration by Period ($000’s omitted)
	Total				2015				2016-2017				2018-2019				After 2019
Other commercial commitments:
Guarantor credit facilities (a)	$	500,000			$	—			$	500,000			$	—			$	—
Non-guarantor credit facilities (b)	150,000				150,000				—				—				—
Total commercial commitments (c)	$	650,000			$	150,000			$	500,000			$	—			$	—

(a)	The $500.0 million in 2016-2017 represents the capacity of our unsecured revolving credit facility, under which no borrowings were outstanding and $208.4 million of letters of credit were issued at December 31, 2014.

(b)	Represents the capacity of the Repurchase Agreement, of which $140.2 million was outstanding at December 31, 2014, and which expires in 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.

(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 homebuilding 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, 2014, we had outstanding letters of credit of $212.1 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, 2014, 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, 2014, these agreements had an aggregate remaining purchase price of $1.9 billion. 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, 2014, we recorded assets of $30.2 million as land, not owned, under option agreements.

At December 31, 2014, aggregate outstanding debt of unconsolidated joint ventures was $25.8 million, of which our proportionate share was $11.6 million. Of this amount, we provided limited recourse guaranties for $0.3 million at December 31, 2014. See Note 5 to the Consolidated Financial Statements for additional information.

Critical Accounting Policies and Estimates

The accompanying consolidated financial statements were prepared in conformity with U.S. 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 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 sale is deferred until the sale of the related mortgage loan to a third-party investor has been completed. If there is a loss on the sale of the property, 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

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 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 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 flow 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 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 loan from the investors or reimburse the investors' losses (a “make-whole” payment).

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.

During 2014, we reduced our loan origination liabilities by $18.6 million based on settlements of various pending repurchase requests and current conditions. During 2012, we recorded $49.0 million of provisions for losses as a change in estimate primarily to reflect projected claim volumes in excess of previous estimates. Reserves provided and related adjustments are reflected in Financial Services expenses. 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.

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. To date, no impairments relating to tradenames have been recorded. 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 become 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

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 product revenue is recognized for each home closing and periodically 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 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.

During 2014, we recorded a change in estimate increasing general liability insurance reserves by $69.3 million. 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. Adjustments to reserves are recorded in the period in which the change in estimate occurs. 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. Costs associated with our insurance programs are classified within selling, general, and administrative expenses.

Our recorded reserves for all such claims totaled $710.2 million and $668.1 million at December 31, 2014 and 2013, respectively, the vast majority of which relate 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 72% and 78% of the total general liability reserves at December 31, 2014 and 2013, 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. 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 $825 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

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 the financial statements or tax returns, judgment is required. Differences between the anticipated and actual outcomes of these future tax consequences could have a material impact on the consolidated results of operations or financial position.

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. 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. Significant judgment is required to evaluate uncertain tax positions. Our evaluations of tax positions consider a variety of factors, including changes in facts or circumstances, changes in law, correspondence with taxing authorities, and effective settlements of audit issues. Changes in the recognition or measurement of uncertain tax positions could result in material increases or decreases in income tax expense (benefit) in the period in which the change is made. Interest and penalties related to unrecognized tax benefits are recognized as a component of income tax expense (benefit).