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

Overview

Improved demand conditions in the overall U.S. housing market continued through 2015. While heightened global economic concerns have created greater volatility in financial markets, the positive trends in the U.S. regarding jobs, demographics and household formations, low interest rates, and a generally balanced inventory of homes available for sale support our expectations that housing demand continues to move higher at a measured pace for a number of years. These conditions have helped keep monthly mortgage payments affordable relative to historical levels and the rental market. This environment contributed to our experiencing relatively stable overall demand in 2015, including 8% growth in net new orders, a 2% increase in home sale revenues to $5.8 billion, and maintaining gross margins at 23.3%, among the highest annual gross margins reported in the Company's history.

The nature of the homebuilding industry results in a lag between when investments made in land acquisition and development yield new community openings and related home closings. During 2015, we opened approximately 200 new communities across our existing local markets, which represented a sizable increase compared with recent years as a result of increased land investment over the last few years. These new communities generally replaced older communities that closed out in 2015 as our overall active community count increased 4%. While we have experience opening new communities, this volume of new community openings presents a challenge in today's environment where entitlement and land development delays are common. The difficult weather conditions in certain parts of the U.S. in the first half of 2015 contributed to that challenge. Additionally, labor constraints in the construction industry have led to delays in home closings, which contributed to our closing volume being flat compared with the prior year. Leveraging our increased land investments, we expect to open an even higher number of new communities in 2016 than we did in 2015, which we expect will help our volume to grow in 2016. In addition, we acquired substantially all of the assets of JW Homes, including the brand John Wieland Homes and Neighborhoods, in January 2016, which will also contribute to growth in 2016.

Our financial position provided flexibility to increase our investments in future communities while also returning funds to shareholders through dividends and expanded share repurchases. Specifically, we accomplished the following in 2015:

•	Increased our land investment spending by 30% to support future growth;

•	Repurchased $433.7 million of shares under our share repurchase plan and authorized an additional $300.0 million for future repurchases;

•	Raised our quarterly dividend from $0.08 to $0.09 per share;

•	Maintained one of the lowest ratios of debt to total capitalization in the homebuilding industry at 30.5%; and

•	Ended the year with a cash balance of $754.2 million with no borrowings outstanding under our unsecured revolving credit agreement.

Industry-wide new home sales continue to pace well below historical averages, so we remain optimistic that demand can continue to increase in the coming years. We believe the positive factors of an improving economy with rising employment, continued low mortgage rates, and beneficial long-term demographic trends 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,
	2015				2014				2013
Income before income taxes:
Homebuilding	$	757,317			$	635,177			$	479,113
Financial Services	58,706				54,581				48,709
Income before income taxes	816,023				689,758				527,822
Income tax expense (benefit)	321,933				215,420				(2,092,294		)
Net income	$	494,090			$	474,338			$	2,620,116
Per share data - assuming dilution:
Net income	$	1.36			$	1.26			$	6.72

•	Homebuilding income before income taxes improved each year from 2013 to 2015, primarily as the result of higher gross margins and revenues. Homebuilding income before income taxes also reflected the following significant expense (income) items ($000's omitted):

	2015				2014				2013
Corporate office relocation (see Note 2)	$	4,369			$	16,344			$	15,376
Land-related charges (see Note 3)	11,467				11,168				9,672
Loss on debt retirements (see Note 6)	—				8,584				26,930
Applecross matter (see Note 12)	20,000				—				—
Settlement of contractual dispute at a closed-out community (see Note 12)	—				—				41,170
Insurance reserve adjustments (see Note 12)	(62,183		)		69,267				—
	$	(26,347	)		$	105,363			$	93,148

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 2015 compared with 2014 and 2013 was primarily due to an increase in mortgage originations. Additionally, we reduced loan loss reserves by $11.4 million in 2015 versus a reduction of $18.6 million in 2014. In 2013, loss reserves remained unchanged. See Note 12.

•	Our effective tax rate was 39.5%, 31.2% and (396.4)% for 2015, 2014, and 2013, respectively. Income tax expense (benefit) reflects provisions and (reversals) of deferred tax asset valuation allowances totaling $3.1 million, $(45.6) million, and $(2.1) billion in 2015, 2014, and 2013, respectively. See Note 9.

Homebuilding Operations

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

	Years Ended December 31,
	2015				FY 2015 vs. FY 2014			2014				FY 2014 vs. FY 2013			2013
Home sale revenues	$	5,792,675			2	%		$	5,662,171			4	%		$	5,424,309
Land sale revenues	48,536				40	%		34,554				(70	)%		114,335
Total Homebuilding revenues	5,841,211				3	%		5,696,725				3	%		5,538,644
Home sale cost of revenues (a)	4,440,893				2	%		4,343,249				1	%		4,310,528
Land sale cost of revenues	35,858				51	%		23,748				(77	)%		104,426
Selling, general, and administrative expenses ("SG&A") (b)	589,780				(12	)%		667,815				17	%		568,500
Other expense, net (c)	17,363				(35	)%		26,736				(65	)%		76,077
Income before income taxes	$	757,317			19	%		$	635,177			33	%		$	479,113
Supplemental data:
Gross margin from home sales	23.3		%		0 bps			23.3		%		280 bps			20.5		%
SG&A as a percentage of home sale revenues	10.2		%		160 bps			11.8		%		130 bps			10.5		%
Closings (units)	17,127				—	%		17,196				(3	)%		17,766
Average selling price	$	338			3	%		$	329			8	%		$	305
Net new orders:
Units	18,008				8	%		16,652				(3	)%		17,080
Dollars (d)	$	6,305,380			13	%		$	5,558,937			3	%		$	5,394,566
Cancellation rate	14		%					15		%					15		%
Active communities at December 31	620				4	%		598				4	%		577
Backlog at December 31:
Units	6,731				15	%		5,850				1	%		5,772
Dollars	$	2,456,565			26	%		$	1,943,861			2	%		$	1,901,796

(a)	Includes the amortization of capitalized interest.

(b)	SG&A includes costs associated with the relocation of our corporate headquarters totaling $2.0 million, $7.6 million, and $15.0 million in 2015, 2014, and 2013, respectively (see Note 2), and adjustments to general liability insurance reserves relating to a reversal of $62.2 million in 2015 and a charge of $69.3 million in 2014 (see Note 12).

(c)

Includes losses related to the redemption of debt totaling $8.6 million and $26.9 million in 2014 and 2013, respectively. Also includes lease exit charges of $2.3 million and $8.7 million in 2015 and 2014, respectively, resulting from the relocation of our corporate headquarters (see Note 2), a charge of $20.0 million in 2015 resulting from the Applecross matter (see Note 12), and charges totaling $41.2 million in 2013 resulting from a contractual dispute related to a previously completed luxury community (see Note 12).

(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 2015 were higher than 2014 by $130.5 million, or 2%. The increase was attributable to a 3% increase in the average selling price while closings remained relatively flat. The increase in average selling price reflects an ongoing shift in our revenue mix toward move-up buyers. Closing volume was flat as higher net new orders were offset by production delays in certain communities caused by a number of factors, including tight labor resources and adverse weather conditions.

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 offset by a 3% decrease in closings. The increase in average selling price occurred in substantially all of our local markets and reflected a shift in our revenue mix toward move-up and active adult buyers along with improved market conditions that 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.

Home sale gross margins

Home sale gross margins were 23.3% in 2015, compared with 23.3% in 2014 and 20.5% in 2013. Gross margins remain strong relative to historical levels and reflect a combination of factors, including shifts in community mix, relatively stable pricing conditions in 2015 following improved pricing conditions in 2014, and lower amortized interest costs (2.4%, 3.4%, and 4.7% of home sale revenues in 2015, 2014, and 2013, respectively), offset by higher house construction and land costs. The lower amortized interest costs resulted from the reduction in our outstanding debt in recent years. Gross margins during 2015 and 2014 were also affected by higher land impairments of $7.3 million and $3.9 million, respectively, compared with $2.9 million in 2013.

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 $12.7 million, $10.8 million, and $9.9 million in 2015, 2014, and 2013, respectively.

SG&A

SG&A as a percentage of home sale revenues was 10.2%, 11.8%, and 10.5% in 2015, 2014, and 2013, respectively. The gross dollar amount of our SG&A decreased $78.0 million, or 12%, in 2015 compared with 2014. SG&A included adjustments to general liability insurance reserves relating to a reversal of $62.2 million in 2015 and a charge of $69.3 million in 2014 (see Note 12). Additionally, we incurred $2.0 million and $7.6 million in 2015 and 2014, respectively, of employee severance, retention, relocation, and related costs attributable to the relocation of our corporate headquarters. Excluding each of these items, SG&A in both dollars and as a percentage of home sale revenues increased for 2015 compared with 2014. This increase in gross overhead dollars in 2015 was primarily due to investments in increased headcount and information systems along with higher costs in conjunction with the opening of approximately 200 new communities.

The gross dollar amount of our SG&A increased $99.3 million, or 17%, in 2014 compared with 2013. SG&A included 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 remainder of the increase in gross overhead dollars in 2014 compared with 2013 were primarily due to variable costs related to the higher revenue volume.

Other expense, net

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

	2015				2014				2013
Write-offs of deposits and pre-acquisition costs (Note 3)	$	5,021			$	6,099			$	3,122
Loss on debt retirements (Note 6)	—				8,584				26,930
Lease exit and related costs	2,463				9,609				2,778
Amortization of intangible assets (Note 1)	12,900				13,033				13,100
Interest income	(3,107		)		(4,632		)		(4,395		)
Interest expense	788				849				712
Equity in (earnings) loss of unconsolidated entities (Note 5)	(7,355		)		(8,226		)		(993		)
Miscellaneous expense, net	6,653				1,420				34,823
	$	17,363			$	26,736			$	76,077

For additional information on each of the above, see the applicable Notes to the Consolidated Financial Statements. Miscellaneous expense, net includes a charge of $20.0 million resulting from the Applecross matter (see Note 12) in 2015 and charges of $41.2 million in 2013 resulting from a contractual dispute related to a previously completed luxury community.

Net new orders

Net new orders increased 8% in 2015 compared with 2014. The increase resulted from improved sales per community combined with selling from a larger number of active communities, which increased 4% to 620 at December 31, 2015. The cancellation rate (canceled orders for the period divided by gross new orders for the period) decreased slightly in 2015 from 2014 at 14% and 15%, respectively. Ending backlog units, which represent orders for homes that have not yet closed, increased 15% at December 31, 2015 compared with December 31, 2014 as measured in units and increased by 26% over the prior year period as measured in dollars. The higher backlog resulted from the higher net new order volume, especially in the fourth quarter, combined with production delays in certain communities in 2015 caused by a number of factors, including tight labor resources and adverse weather conditions. The higher average sales price also contributed to the higher backlog dollars.

Net new orders decreased 3% in 2014 compared with 2013, primarily as the result of fewer active communities throughout the majority of 2014. The number of active communities increased slightly in 2014 compared with 2013 (up 4% to 598 active communities at December 31, 2014), though this was primarily due to our acquisition of certain real estate assets from Dominion Homes in August 2014 (see Note 1). 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 was unchanged from 2013 to 2014 at 15%. Ending backlog units increased 1% at December 31, 2014 compared with December 31, 2013 and increased 2% 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, 2015 and 2014:

		2015			2014
Sold		4,573			3,761
Unsold
Under construction		1,450			815
Completed		471			483
		1,921			1,298
Models		1,024			981
Total		7,518			6,040

The number of homes in production at December 31, 2015 was 24% higher compared to December 31, 2014. The increase in homes under production was due to a combination of factors, including a 4% increase in active communities, a 15% increase in ending backlog units, and a conscious decision to moderately increase the number of unsold homes under construction ("spec homes") at the end of the year. The increase in spec homes reflects our intentions to achieve a more even

flow production cycle over the course of 2016 compared with 2015. As part of our inventory management strategy, we will continue to maintain reasonable inventory levels relative to demand in each of our markets. We continue to focus on maintaining a low level of 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, 2015 and 2014:

		December 31, 2015									December 31, 2014
		Owned			Optioned			Controlled			Owned			Optioned			Controlled
Northeast		6,361			4,114			10,475			6,389			4,185			10,574
Southeast		11,161			7,933			19,094			11,195			4,785			15,980
Florida		21,230			9,636			30,866			20,511			7,119			27,630
Midwest		13,093			6,985			20,078			14,571			5,714			20,285
Texas		13,308			7,052			20,360			11,847			7,435			19,282
West		30,766			6,440			37,206			31,707			5,335			37,042
Total		95,919			42,160			138,079			96,220			34,573			130,793
Developed (%)		28	%		12	%		23	%		25	%		23	%		25	%

Of our controlled lots, 95,919 and 96,220 were owned and 42,160 and 34,573 were under land option agreements at December 31, 2015 and 2014, respectively. While competition for well-positioned land is robust, we continue to pursue strategic land positions that drive appropriate returns on invested capital. The remaining purchase price under our land option agreements totaled $2.0 billion at December 31, 2015. 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 $162.1 million, of which $10.5 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, 2015, we conducted our operations in 50 markets located throughout 26 states. For reporting purposes, our Homebuilding operations are aggregated into six reportable segments. For 2015, we realigned our organizational structure and reportable segment presentation. Accordingly, the segment information provided in this note has been reclassified to conform to the current presentation for all periods presented.

Northeast:		Connecticut, Maryland, Massachusetts, New Jersey, New York, Pennsylvania, Rhode Island, Virginia
Southeast:		Georgia, North Carolina, South Carolina, Tennessee
Florida:		Florida
Midwest:		Illinois, Indiana, Kentucky, Michigan, Minnesota, Missouri, Ohio
Texas:		Texas
West:		Arizona, California, Nevada, New Mexico, Washington

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,
	2015				FY 2015 vs. FY 2014			2014				FY 2014 vs. FY 2013			2013
Home sale revenues:
Northeast	$	679,082			(4	)%		$	708,465			(10	)%		$	784,087
Southeast	1,058,055				11	%		949,134				13	%		842,856
Florida	1,012,391				11	%		913,758				14	%		800,331
Midwest	1,012,460				16	%		869,271				10	%		786,930
Texas	840,766				(2	)%		856,613				6	%		804,806
West	1,189,921				(13	)%		1,364,930				(3	)%		1,405,299
	$	5,792,675			2	%		$	5,662,171			4	%		$	5,424,309
Income before income taxes:
Northeast	$	82,616			(20	)%		$	103,865			(6	)%		$	110,246
Southeast	172,330				10	%		156,513				29	%		121,055
Florida	196,525				3	%		190,441				36	%		139,673
Midwest	91,745				16	%		78,863				(7	)%		84,551
Texas	121,329				(9	)%		133,005				19	%		111,431
West	169,394				(33	)%		254,724				(2	)%		258,960
Other homebuilding (a)	(76,622		)		73	%		(282,234		)		19	%		(346,803		)
	$	757,317			19	%		$	635,177			33	%		$	479,113
Closings (units):
Northeast	1,496				(5	)%		1,568				(15	)%		1,835
Southeast	3,276				4	%		3,160				5	%		3,022
Florida	2,896				5	%		2,752				—	%		2,747
Midwest	2,961				15	%		2,581				10	%		2,352
Texas	3,357				(10	)%		3,750				—	%		3,768
West	3,141				(7	)%		3,385				(16	)%		4,042
	17,127				—	%		$	17,196			(3	)%		17,766
Average selling price:
Northeast	$	454			—	%		$	452			6	%		$	427
Southeast	323				8	%		300				8	%		279
Florida	350				5	%		332				14	%		291
Midwest	342				2	%		337				1	%		335
Texas	250				10	%		228				7	%		214
West	379				(6	)%		403				16	%		348
	$	338			3	%		$	329			8	%		$	305

(a)

Other homebuilding includes the amortization of intangible assets, amortization of capitalized interest, and other items not allocated to the operating segments, in addition to: losses on debt retirements of $8.6 million and $26.9 million in 2014 and 2013, respectively (see Note 6); adjustments to general liability insurance reserves relating to a reversal of $62.2 million in 2015 and a charge of $69.3 million in 2014 (see Note 12); costs associated with the relocation of our corporate headquarters totaling $4.4 million, $16.3 million, and $15.4 million in 2015, 2014, and 2013, respectively (see Note 2); and charges of $41.2 million in 2013 resulting from a contractual dispute related to a previously completed luxury community (see Note 12).

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

		Operating Data by Segment ($000's omitted)
		Years Ended December 31,
		2015				FY 2015 vs. FY 2014			2014				FY 2014 vs. FY 2013			2013
Net new orders - units:
Northeast		1,479				5	%		1,408				(23	)%		1,834
Southeast		3,454				12	%		3,075				(3	)%		3,164
Florida		3,168				12	%		2,841				9	%		2,595
Midwest		2,862				23	%		2,329				(1	)%		2,361
Texas		3,429				(9	)%		3,773				6	%		3,563
West		3,616				12	%		3,226				(9	)%		3,563
		18,008				8	%		16,652				(3	)%		17,080
Net new orders - dollars:
Northeast		$	674,637			4	%		$	649,202			(17	)%		$	782,474
Southeast		1,160,590				23	%		944,567				5	%		895,800
Florida		1,152,705				21	%		954,892				16	%		820,032
Midwest		1,024,784				26	%		815,968				5	%		778,485
Texas		905,003				3	%		881,843				11	%		796,377
West		1,387,661				6	%		1,312,465				(1	)%		1,321,398
		$	6,305,380			13	%		$	5,558,937			3	%		$	5,394,566
Cancellation rates:
Northeast		12		%					12		%					13		%
Southeast		10		%					12		%					12		%
Florida		11		%					10		%					13		%
Midwest		13		%					13		%					10		%
Texas		19		%					19		%					22		%
West		18		%					18		%					17		%
		14		%					15		%					15		%
Unit backlog:
Northeast		444				(4	)%		461				(26	)%		621
Southeast		1,146				18	%		968				(8	)%		1,053
Florida		1,274				27	%		1,002				10	%		913
Midwest		1,089				(8	)%		1,188				45	%		818
Texas		1,345				6	%		1,273				2	%		1,250
West		1,433				50	%		958				(14	)%		1,117
		6,731				15	%		5,850				1	%		5,772
Backlog dollars:
Northeast		$	211,532			(2	)%		$	215,977			(22	)%		$	275,239
Southeast		403,568				34	%		301,033				(1	)%		305,600
Florida		490,282				40	%		349,968				13	%		308,834
Midwest		382,360				3	%		370,036				33	%		278,040
Texas		375,660				21	%		311,424				9	%		286,195
West		593,163				50	%		395,423				(12	)%		447,888
		$	2,456,565			26	%		$	1,943,861			2	%		$	1,901,796

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

		Operating Data by Segment ($000's omitted)
		Years Ended December 31,
		2015				FY 2015 vs. FY 2014			2014				FY 2014 vs. FY 2013			2013
Land-related charges*:
Northeast		$	3,301			17	%		$	2,824			407	%		$	557
Southeast		3,022				65	%		1,826				83	%		998
Florida		4,555				835	%		487				(55	)%		1,076
Midwest		2,319				(1	)%		2,347				25	%		1,883
Texas		295				(8	)%		321				68	%		191
West		(2,615		)		(254	)%		1,696				(16	)%		2,023
Other homebuilding		590				(65	)%		1,667				(43	)%		2,944
		$	11,467			3	%		$	11,168			15	%		$	9,672

*	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 2015, Northeast home sale revenues decreased 4% compared with 2014 due to a 5% decrease in closings. Average selling price remained flat over 2014. The decrease in closings occurred in Mid-Atlantic and New England and contributed

to the lower income before income taxes. However, the decreased income before income taxes resulted primarily from a charge of $20.0 million resulting from the Applecross matter (see Note 12). Net new orders increased 5%, primarily due to increased order levels in the Northeast Corridor.

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 the average selling price occurred primarily in New England and the Mid-Atlantic. The decreased income before income taxes resulted from lower revenue and gross margins combined and increased overhead. Net new orders decreased 23%, reflecting lower order levels across all divisions due in part to a lower active community count.

Southeast:

For 2015, Southeast home sale revenues increased 11% compared with 2014 due to an 8% increase in the average selling price combined with a 4% increase in closings. The increase in the average selling price and closings were broad-based, though Tennessee experienced declines. The increased income before income taxes resulted primarily from higher revenues. Net new orders increased 12% in 2015 mainly due to increased order levels in Raleigh and Georgia, partially offset by a decline in Tennessee.

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 the 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 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.

Florida:

For 2015, Florida home sale revenues increased 11% compared with 2014 due to a 5% increase in the average selling price combined with a 5% increase in closings. The increase in average selling price occurred in both North and South Florida. The increased income before income taxes for 2015 resulted primarily from higher revenues. Net new orders increased by 12% in 2015 due primarily to an increase in active communities in North and West 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 the average selling price occurred in both North and South Florida. Closings remained flat compared with the prior year as an 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 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

Midwest:

For 2015, Midwest home sale revenues increased 16% compared with the prior year period due to a 15% increase in closings combined with a 2% increase in the average selling price. The increase in closing volumes was driven by our acquisition of certain real estate assets from Dominion Homes in August 2014. Partially offsetting this were lower closings in Illinois-St Louis. The increased income before income taxes was due primarily to higher revenues. Net new orders increased by 23% in 2015 compared with 2014, mainly due to the acquisition of certain real estate assets from Dominion Homes combined with higher orders in Indianapolis-Cleveland and Minnesota.

For 2014, Midwest home sale revenues increased 10% compared with the prior year period due to a 10% increase in closings and a 1% increase in the average selling price. The increase in closing volumes was primarily due to the acquisition of certain real estate assets from Dominion Homes in August 2014, combined with increases in both Michigan and Indianapolis-Cleveland. The decreased income before income taxes resulted from higher overhead. Net new orders decreased by 1% in 2014 compared with 2013, mainly due to decreases in Illinois-St. Louis and Minnesota, partially offset by an increase due to the acquisition of certain real estate assets from Dominion Homes.

Texas:

For 2015, Texas home sale revenues decreased by 2% compared with the prior year period due to a 10% decrease in closings, partially offset by a 10% increase in the average selling price. These trends were broad-based, though Houston's closings were down 16%, in part due to the impact of lower oil prices on the local economy. In other markets, the lower closings resulted primarily from tight labor resources combined with delays in opening new communities, in part due to challenging weather conditions earlier in the year. The lower revenues led to the decreased income before income taxes for 2015. Net new orders decreased by 9% for 2015 led by a 19% decline in Houston.

For 2014, Texas home sale revenues increased 6% compared with the prior year period due to a 7% increase in the average selling price. The increase in the 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 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.

West:

For 2015, West home sale revenues decreased 13% compared with the prior year period due to a 7% decrease in closings combined with a 6% decrease in the average selling price. The decreased closings and decreased average selling price were driven primarily by the Pacific Northwest, Northern California, and Southern California as the result of the timing of our community openings combined with a shift in the mix of closings toward lower priced communities. The decreased income before income taxes resulted from lower revenues, lower gross margins, and higher overhead as we invested in new communities. Net new orders increased by 12% in 2015 compared with 2014 due to higher order levels across all divisions except the Pacific Northwest and Southern California.

For 2014, West home sale revenues decreased 3% compared with the prior year period due to a 16% decrease in closings, offset by a 16% increase in average selling price. Both the decrease in closings and the increase in the average selling price occurred across all divisions. The decreased income before income taxes resulted from lower revenues. Net new orders decreased by 9% in 2014 compared with 2013 primarily due to fewer active communities. Demand in Northern California in particular slowed in 2014 compared with the strong demand experienced in 2013.

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 third parties. 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 loans and related 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,
	2015				FY 2015 vs. FY 2014			2014				FY 2014 vs. FY 2013			2013
Mortgage operations revenues	$	111,810			14	%		$	97,787			(14	)%		$	113,552
Title services revenues	28,943				4	%		27,851				2	%		27,399
Total Financial Services revenues	140,753				12	%		125,638				(11	)%		140,951
Expenses (a)	82,047				15	%		71,057				(23	)%		92,242
Income before income taxes	$	58,706			8	%		$	54,581			12	%		$	48,709
Total originations:
Loans	11,435				6	%		10,805				(9	)%		11,818
Principal	$	2,929,531			10	%		$	2,656,683			(4	)%		$	2,765,509

(a) Includes loan origination reserve releases of $11.4 million and $18.6 million in 2015 and 2014, respectively.

	Years Ended December 31,
	2015				2014				2013
Supplemental data:
Capture rate	82.9		%		80.2		%		80.2		%
Average FICO score	749				749				746
Loan application backlog	$	1,310,173			$	980,863			$	984,754
Funded origination breakdown:
FHA	11		%		10		%		16		%
VA	13		%		12		%		11		%
USDA	1		%		2		%		3		%
Other agency	69		%		70		%		67		%
Total agency	94		%		94		%		97		%
Non-agency	6		%		6		%		3		%
Total funded originations	100		%		100		%		100		%

Revenues

Total Financial Services revenues during 2015 increased 12% compared with 2014. The increase resulted from a higher capture rate and higher revenues per loan, which were attributable to a higher average loan size combined with a modest improvement in loan pricing. The improvement in loan pricing resulted primarily from a spike in mortgage industry refinancing volume in early 2015, which reduced competitive pricing pressures for new originations. Loan pricing came under more pressure in more recent months as industry refinancing volume receded. However, the overall pricing environment for new originations remains favorable.

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 increased competitiveness in the mortgage industry that began in 2013.

Since 2007, the mortgage industry has experienced a significant overall tightening of lending standards and a shift toward agency production. Adjustable rate mortgages (“ARMs”) accounted for 6% of funded loan production in 2015 compared with 11% and 5% in 2014 and 2013, respectively. The shifts in ARM volume contributed to the higher revenue per loan in 2015 and lower revenue per loan in 2014 as ARMs generally contain lower margins. Additionally, fixed rate mortgages tend to have higher servicing values.

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

During 2015 and 2014, we reduced our loan origination liabilities by $11.4 million and $18.6 million, respectively, based on probable settlements of various repurchase requests and current conditions. Non-cash changes in reserve levels 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.

Income before income taxes

The increased income before income taxes for 2015 as compared with 2014 is due to higher origination volume and an increase in revenue per loan. The increase in expenses over the prior period is largely a result of an increase in headcount caused by the higher origination volume, combined with the impact of changes in loan loss reserves discussed above.

The increased income before income taxes for 2014 as compared with 2013 resulted from the lower loss reserves in 2014 discussed above, partially offset by less favorable loan pricing.

Income Taxes

Our effective tax rate was 39.5%, 31.2% and (396.4)% for 2015, 2014, and 2013 respectively. The 2015 effective tax rate exceeds the federal statutory rate, primarily due to state taxes including changes in valuation allowance on state deferred tax assets and revaluation of deferred tax assets due to state law changes and business operations. The 2014 effective tax rate is less than the federal statutory rate primarily due to reversal of a portion of our valuation allowance related to certain state deferred tax assets, along with the favorable resolution of certain federal and state income tax matters. The 2013 effective tax rate differed from the federal statutory rate primarily due to the reversal of substantially all of the valuation allowance related to our federal and certain state deferred tax assets.

Income tax expense (benefit) reflects provisions and (reversals) related to changes to our deferred tax asset valuation allowances totaling $3.1 million, $(45.6) million, and $(2.1) billion in 2015, 2014, and 2013, respectively. The 2015 and 2014 adjustments related primarily to certain of our state deferred tax assets as the result of changes 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 were more favorable than in recent years and our belief that conditions would continue to be favorable in the future.

Liquidity and Capital Resources

We finance our land acquisition, development, and construction activities and financial services operations 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 and may determine that modifications to our financing are appropriate.

At December 31, 2015, we had unrestricted cash and equivalents of $754.2 million, senior notes of $1.6 billion, and borrowings of $500.0 million under a term loan. We also had restricted cash balances of $21.3 million. We follow a diversified investment approach for our cash and equivalents by maintaining such funds with a broad portfolio of banks within our group of relationship banks in high quality, highly liquid, short-term deposits and investments. 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 30.5% at December 31, 2015.

We retired $238.0 million, $245.7 million, and $461.4 million of senior notes during 2015, 2014, and 2013, respectively. The 2014 and 2013 retirements occurred prior to the stated maturity dates and resulted in losses totaling $8.6 million and $26.9 million in 2014 and 2013, 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 $500.0 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) $300.0 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, 2015, we had no borrowings outstanding and $191.3 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, 2015, we were in compliance with all covenants. Outstanding balances under the Revolving Credit Facility are guaranteed by certain of our wholly-owned subsidiaries.

Term loan

On September 30, 2015, we entered into a senior unsecured $500.0 million term loan agreement (the “Term Loan”) with an initial maturity date of January 3, 2017, which can be extended at our option up to 12 months. The interest rate on the Term Loan may be based on either LIBOR or a base rate plus an applicable margin, as defined. Borrowings are guaranteed by certain of our wholly-owned subsidiaries, and the Term Loan contains customary affirmative and negative covenants for loans of this type, including the same financial covenants as under the Revolving Credit Facility. As of December 31, 2015, we were in compliance with all covenants.

Limited recourse notes payable

Certain of our local homebuilding operations maintain limited recourse collateralized notes payable with third parties totaling $35.3 million at December 31, 2015. These notes have maturities ranging up to six 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. The stated interest rates on these notes range up to 5.00%.

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. Pulte Mortgage uses these resources to finance its lending activities until the 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 2015, Pulte Mortgage entered into an amendment to the Repurchase Agreement that extended the effective date to September 2016. The Repurchase Agreement was subsequently amended in December 2015 to increase the borrowing capacity to $310.0 million. The capacity decreased to $175.0 million on January 19, 2016, and increases to $200.0 million on July 29, 2016. The purpose for the changes in capacity during the term of the agreement is to lower associated fees during seasonally lower volume periods of mortgage origination activity. 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 $267.9 million and $140.2 million outstanding under the Repurchase Agreement at December 31, 2015, and 2014, respectively, and was in compliance with its covenants and requirements as of such dates.

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, and a further increase of $300.0 million in December 2015. We repurchased 21.2 million, 12.9 million, and 7.2 million shares in 2015, 2014, and 2013, respectively, for a total of $433.7 million, $245.8 million, and $118.1 million in 2015, 2014, and 2013, respectively. At December 31, 2015, we had remaining authorization to repurchase $604.8 million of common shares.

Dividends

We reinstated our quarterly cash dividend in July 2013 and subsequently raised the quarterly dividend in both 2014 and 2015. Our declared quarterly cash dividends totaled $117.9 million, $86.4 million, and $57.5 million in 2015, 2014, and 2013, respectively.

Cash flows

Operating activities

Our net cash used in operating activities in 2015 was $348.1 million, compared with cash provided by operating activities of $309.2 million and $881.1 million in 2014 and 2013, respectively. Generally, the primary drivers of our cash flow from operations are profitability and changes in inventory levels. Our negative cash flow from operations for 2015 was primarily due to an increase in inventories of $927.8 million as the result of a significant increase in land acquisition and development investment combined with a moderate increase in house inventory due to the higher order backlog and an increase in the number of spec homes consistent with our intentions to achieve a more even flow production cycle over the course of 2016 compared with 2015. The increased inventory was offset by our income before income taxes of $816.0 million. Additionally, residential mortgage loans available-for-sale increased $104.6 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 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 and an increase in residential mortgage loans available-for-sale of $53.7 million.

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 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.

Investing activities

Investing activities are generally not a significant source or use of cash for us. Net cash used in investing activities totaled $30.9 million in 2015, compared with $67.6 million in 2014 and $46.0 million in 2013. The use of cash from investing activities in 2015 was primarily due to capital expenditures as the result of new community openings.

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) and $48.8 million of capital expenditures related primarily to new community openings and the relocation of our corporate headquarters. These cash outflows were partially offset by a $55.0 million reduction in the 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.

Financing activities

Net cash used in financing activities was $159.7 million in 2015, compared with $529.1 million and $659.6 million in 2014 and 2013, respectively. The net cash used in financing activities for 2015 resulted primarily from the repurchase of 21.2 million common shares for $433.7 million under our repurchase authorization, payment of $239.2 million to retire senior notes at their scheduled maturity date, and payment of $116.0 million in cash dividends. These cash outflows were offset by $500.0 million of proceeds from the Term Loan executed in September 2015 and net borrowings of $127.6 million under the Repurchase Agreement to fund the increase in mortgage loans available-for-sale.

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 $239.2 million, $250.6 million, and $479.8 million of cash in 2015, 2014, and 2013, respectively. We borrowed an incremental $34.6 million under the Repurchase Agreement during 2014, and repaid $33.1 million in 2013. Cash used in financing activities for 2014 also reflects dividend payments of $75.6 million and the repurchase of common shares under our share repurchase authorization 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, 2015:

	Payments Due by Period ($000’s omitted)
	Total				2016				2017-2018				2019-2020				After 2020
Contractual obligations:
Long-term debt (a)	$	3,317,336			$	564,392			$	767,256			$	134,250			$	1,851,438
Operating lease obligations	128,129				28,561				39,673				24,921				34,974
Other long-term liabilities (b)	38,261				23,410				6,173				8,678				—
Total contractual obligations (c)	$	3,483,726			$	616,363			$	813,102			$	167,849			$	1,886,412

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

(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, 2015, we had $162.1 million of deposits and pre-acquisition costs, of which $10.5 million is refundable, relating to option agreements to acquire 42,160 lots with a remaining purchase price of $2.0 billion. We expect to acquire the majority of such land within the next two years and the remainder thereafter.

At December 31, 2015, we had $39.0 million of gross unrecognized tax benefits and $17.2 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 2005 - 2015.

The following table summarizes our other commercial commitments as of December 31, 2015:

	Amount of Commitment Expiration by Period ($000’s omitted)
	Total				2016				2017-2018				2019-2020				After 2020
Other commercial commitments:
Guarantor credit facilities (a)	$	500,000			$	—			$	500,000			$	—			$	—
Non-guarantor credit facilities (b)	310,000				310,000				—				—				—
Total commercial commitments (c)	$	810,000			$	310,000			$	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 $191.3 million of letters of credit were issued at December 31, 2015.

(b)	Represents the capacity of the Repurchase Agreement, of which $267.9 million was outstanding at December 31, 2015, and which expires in September 2016. The capacity decreased to $175.0 million on January 19, 2016, and increases to $200.0 million on July 29, 2016.

(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, 2015, we had outstanding letters of credit of $191.3 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, 2015, 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, 2015, these agreements had an aggregate remaining purchase price of $2.0 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.

At December 31, 2015, aggregate outstanding debt of unconsolidated joint ventures was $16.4 million, of which our proportionate share was $7.0 million. Of this amount, we provided limited recourse guaranties for $0.2 million at December 31, 2015. 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 and cost of revenues

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).

Estimating the required liability for these potential losses requires a significant level of management judgment. During 2015 and 2014, we reduced our loan origination liabilities by $11.4 million and $18.6 million, respectively, based on probable settlements of various repurchase requests and current conditions. Reserves provided (released) 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 cash flows 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.

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).

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. 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.

Housing market conditions have been volatile across most of our markets over the past ten years, and we believe such conditions can affect the frequency and cost of construction defect claims. Additionally, IBNR estimates comprise the majority 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. Changes in the frequency and timing of reported claims and estimates of specific claim values can impact the underlying inputs and trends utilized in the actuarial analyses, which could have a material impact on the recorded reserves. Additionally, the amount of insurance coverage available for each policy period also impacts our recorded reserves. Because of the inherent uncertainty in estimating future losses and the timing of such losses related to these claims, actual costs could differ significantly from estimated costs.

Adjustments to reserves are recorded in the period in which the change in estimate occurs. During 2015, we recorded general liability reserve reversals of $32.6 million resulting from a legal settlement and $29.6 million related to changes in our actuarial estimates resulting from favorable claims experience relative to previous actuarial projections. During 2014, we increased general liability insurance reserves by $69.3 million, which was primarily driven by estimated costs associated with siding repairs in certain previously completed communities that, in turn, impacted actuarial estimates for potential future claims.

Our recorded reserves for all such claims totaled $692.1 million and $710.2 million at December 31, 2015 and 2014, 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 65% and 72% of the total general liability reserves at December 31, 2015 and 2014, 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 $625 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.