Quarterly Report (10-q)

Date : 07/23/2019 @ 8:00PM
Source : Edgar (US Regulatory)
Stock : PulteGroup Inc (PHM)
Quote : 38.8  0.62 (1.62%) @ 10:14PM
After Hours
Last Trade
Last $ 38.80 ◊ 0.00 (0.00%)

Quarterly Report (10-q)

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

 
 OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2019

or
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)


 
OF THE SECURITIES EXCHANGE ACT OF 1934



Commission File Number 1-9804

PULTEGROUP, INC.
(Exact name of registrant as specified in its charter) 
Michigan
38-2766606
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
3350 Peachtree Road NE, Suite 150
Atlanta,
Georgia
30326
(Address of principal executive offices) (Zip Code)

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

Securities registered pursuant to Section 12(b) of the Act:
Title of each class
 
Trading Symbol(s)
 
Name of each exchange on which registered
Common Shares, par value $0.01
 
PHM
 
New York Stock Exchange

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

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes   [X]   NO  [ ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer”, “accelerated filer”, “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
  
Accelerated filer
  
Non-accelerated filer
  
Smaller reporting company
Emerging growth company
 
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [ ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  
YES
No
 
Number of common shares outstanding as of July 18, 2019 : 274,218,679

1


PULTEGROUP, INC.
TABLE OF CONTENTS

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

 
 
 
PART II
 
 
 
Item 2
 
 
 
Item 6
 
 
 
 
 





2


PART I. FINANCIAL INFORMATION

Item 1.      Financial Statements

PULTEGROUP, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
($000’s omitted)
 
 
June 30,
2019
 
December 31,
2018
 
(Unaudited)
 
 
ASSETS
 
 
 
 
 
 
 
Cash and equivalents
$
631,309

 
$
1,110,088

Restricted cash
27,965

 
23,612

Total cash, cash equivalents, and restricted cash
659,274

 
1,133,700

House and land inventory
7,802,492

 
7,253,353

Land held for sale
38,218

 
36,849

Residential mortgage loans available-for-sale
343,732

 
461,354

Investments in unconsolidated entities
58,246

 
54,590

Other assets
837,279

 
830,359

Intangible assets
132,192

 
127,192

Deferred tax assets, net
224,104

 
275,579

 
$
10,095,537

 
$
10,172,976

 
 
 
 
LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
 
 
 
 
Liabilities:
 
 
 
Accounts payable
$
380,363

 
$
352,029

Customer deposits
334,484

 
254,624

Accrued and other liabilities
1,308,459

 
1,360,483

Income tax liabilities
27,913

 
11,580

Financial Services debt
234,186

 
348,412

Notes payable
2,740,325

 
3,028,066

 
5,025,730

 
5,355,194

Shareholders' equity
5,069,807

 
4,817,782

 
$
10,095,537

 
$
10,172,976





See accompanying Notes to Condensed Consolidated Financial Statements.


3


PULTEGROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(000’s omitted, except per share data)
(Unaudited)
 
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2019
 
2018
 
2019
 
2018
Revenues:
 
 
 
 
 
 
 
Homebuilding
 
 
 
 
 
 
 
Home sale revenues
$
2,403,559

 
$
2,450,054

 
$
4,353,415

 
$
4,361,652

Land sale and other revenues
29,469

 
66,904

 
32,445

 
79,461

 
2,433,028

 
2,516,958

 
4,385,860

 
4,441,113

Financial Services
55,957

 
52,764

 
99,819

 
98,702

Total revenues
2,488,985

 
2,569,722

 
4,485,679

 
4,539,815

 
 
 
 
 
 
 
 
Homebuilding Cost of Revenues:
 
 
 
 
 
 
 
Home sale cost of revenues
(1,848,155
)
 
(1,862,133
)
 
(3,340,946
)
 
(3,322,073
)
Land sale cost of revenues
(26,214
)
 
(38,183
)
 
(28,265
)
 
(49,731
)
 
(1,874,369
)
 
(1,900,316
)
 
(3,369,211
)
 
(3,371,804
)
 
 
 
 
 
 
 
 
Financial Services expenses
(30,901
)
 
(32,224
)
 
(62,350
)
 
(64,436
)
Selling, general, and administrative expenses
(259,440
)
 
(226,056
)
 
(512,166
)
 
(466,950
)
Other expense, net
(3,499
)
 
(1,956
)
 
(4,473
)
 
(3,263
)
Income before income taxes
320,776

 
409,170

 
537,479

 
633,362

Income tax expense
(79,735
)
 
(85,081
)
 
(129,681
)
 
(138,521
)
Net income
$
241,041

 
$
324,089

 
$
407,798

 
$
494,841

 
 
 
 
 
 
 
 
Per share:
 
 
 
 
 
 
 
Basic earnings
$
0.86

 
$
1.12

 
$
1.46

 
$
1.72

Diluted earnings
$
0.86

 
$
1.12

 
$
1.45

 
$
1.71

Cash dividends declared
$
0.11

 
$
0.09

 
$
0.22

 
$
0.18

 
 
 
 
 
 
 
 
Number of shares used in calculation:



 
 
 
 
Basic
276,652

 
285,276

 
277,142

 
285,976

Effect of dilutive securities
932

 
1,378

 
967

 
1,088

Diluted
277,584

 
286,654

 
278,109

 
287,064




See accompanying Notes to Condensed Consolidated Financial Statements.


4


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

 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2019
 
2018
 
2019
 
2018
Net income
$
241,041

 
$
324,089

 
$
407,798

 
$
494,841

 
 
 
 
 
 
 
 
Other comprehensive income, net of tax:
 
 
 
 
 
 
 
Change in value of derivatives
25

 
30

 
50

 
50

Other comprehensive income
25

 
30

 
50

 
50

 
 
 
 
 
 
 
 
Comprehensive income
$
241,066

 
$
324,119

 
$
407,848

 
$
494,891






See accompanying Notes to Condensed Consolidated Financial Statements.


5



PULTEGROUP, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
(000's omitted)
(Unaudited)
 
Common Stock
 
Additional
Paid-in
Capital
 
Accumulated
Other
Comprehensive
Income
(Loss)
 
Retained
Earnings
 
Total
Shares
 
$
 
Shareholders' Equity, December 31, 2018
277,110

 
$
2,771

 
$
3,201,427

 
$
(345
)
 
$
1,613,929

 
$
4,817,782

Stock option exercises
118

 
1

 
1,444

 

 

 
1,445

Share issuances
1,337

 
12

 
5,792

 

 

 
5,804

Dividends declared

 

 

 

 
(30,831
)
 
(30,831
)
Share repurchases
(1,309
)
 
(13
)
 

 

 
(35,340
)
 
(35,353
)
Share-based compensation

 

 
7,810

 

 

 
7,810

Net income

 

 

 

 
166,757

 
166,757

Other comprehensive income

 

 

 
25

 

 
25

Shareholders' Equity, March 31, 2019
277,256

 
$
2,771

 
$
3,216,473

 
$
(320
)
 
$
1,714,515

 
$
4,933,439

Stock option exercises
316

 
3

 
3,760

 

 

 
3,763

Share issuances
26

 
2

 
(2
)
 

 

 

Dividends declared

 

 

 

 
(30,633
)
 
(30,633
)
Share repurchases
(2,623
)
 
(26
)
 

 

 
(83,445
)
 
(83,471
)
Share-based compensation

 

 
5,642

 

 

 
5,642

Net income

 

 

 

 
241,041

 
241,041

Other comprehensive income

 

 

 
25

 

 
25

Shareholders' Equity, June 30, 2019
274,975

 
$
2,750

 
$
3,225,874

 
$
(295
)
 
$
1,841,478

 
$
5,069,807

 
 
 
 
 
 
 
 
 
 
 
 
Shareholders' Equity, December 31, 2017
286,752

 
$
2,868

 
$
3,171,542

 
$
(445
)
 
$
980,061

 
$
4,154,026

Cumulative effect of accounting change (see Note 1 )

 

 

 

 
22,411

 
22,411

Stock option exercises
284

 
3

 
2,720

 

 

 
2,723

Share issuances
783

 
8

 
3,477

 

 

 
3,485

Dividends declared

 

 

 

 
(26,051
)
 
(26,051
)
Share repurchases
(1,941
)
 
(20
)
 

 

 
(59,471
)
 
(59,491
)
Share-based compensation

 

 
6,782

 

 

 
6,782

Net income

 

 

 

 
170,751

 
170,751

Other comprehensive income

 

 

 
21

 

 
21

Shareholders' Equity, March 31, 2018
285,878

 
$
2,859

 
$
3,184,521

 
$
(424
)
 
$
1,087,701

 
$
4,274,657

Stock option exercises
150

 
1

 
1,743

 

 

 
1,744

Share issuances
87

 

 
(2
)
 

 

 
(2
)
Dividends declared

 

 

 

 
(25,915
)
 
(25,915
)
Share repurchases
(1,753
)
 
(17
)
 
(284
)
 

 
(52,699
)
 
(53,000
)
Share-based compensation

 

 
5,109

 

 

 
5,109

Net income

 

 

 

 
324,089

 
324,089

Other comprehensive income

 

 

 
30

 

 
30

Shareholders' Equity, June 30, 2018
284,362

 
$
2,843

 
$
3,191,087

 
$
(395
)
 
$
1,333,176

 
$
4,526,712


(a) Due to rounding, the sum of quarterly activity may not equal year-to-date totals

See accompanying Notes to Condensed Consolidated Financial Statements.

6


PULTEGROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
($000’s omitted)
(Unaudited)
 
Six Months Ended
 
June 30,
 
2019
 
2018
Cash flows from operating activities:
 
 
 
Net income
$
407,798

 
$
494,841

Adjustments to reconcile net income to net cash from operating activities:
 
 
 
Deferred income tax expense
51,458

 
126,991

Land-related charges
6,810


5,841

Depreciation and amortization
26,497

 
24,161

Share-based compensation expense
17,304

 
16,162

Other, net
2,664

 
(2,803
)
Increase (decrease) in cash due to:
 
 
 
Inventories
(399,520
)
 
(281,362
)
Residential mortgage loans available-for-sale
116,974

 
199,623

Other assets
31,593

 
15,822

Accounts payable, accrued and other liabilities
44,132

 
(51,694
)
Net cash provided by (used in) operating activities
305,710

 
547,582

Cash flows from investing activities:
 
 
 
Capital expenditures
(29,575
)
 
(33,059
)
Investments in unconsolidated entities
(4,664
)
 
(1,000
)
Business acquisition
(163,724
)
 

Other investing activities, net
4,592

 
6,915

Net cash provided by (used in) investing activities
(193,371
)
 
(27,144
)
Cash flows from financing activities:
 
 
 
Repayments of notes payable
(297,303
)
 
(82,432
)
Borrowings under revolving credit facility

 
1,566,000

Repayments under revolving credit facility

 
(1,566,000
)
Financial Services borrowings (repayments)
(114,226
)
 
(173,761
)
Debt issuance costs

 
(8,090
)
Stock option exercises
5,208

 
4,467

Share repurchases
(118,824
)
 
(112,491
)
Dividends paid
(61,620
)
 
(52,384
)
Net cash provided by (used in) financing activities
(586,765
)
 
(424,691
)
Net increase (decrease) in cash, cash equivalents, and restricted cash
(474,426
)
 
95,747

Cash, cash equivalents, and restricted cash at beginning of period
1,133,700

 
306,168

Cash, cash equivalents, and restricted cash at end of period
$
659,274

 
$
401,915

 
 
 
 
Supplemental Cash Flow Information:
 
 
 
Interest paid (capitalized), net
$
5,560

 
$
(387
)
Income taxes paid (refunded), net
$
12,618

 
$
77,077



See accompanying Notes to Condensed Consolidated Financial Statements.

7


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


1. Basis of presentation

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

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles ("GAAP") for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal, recurring adjustments) considered necessary for a fair presentation have been included. Operating results for the interim periods presented are not necessarily indicative of the results that may be expected for the full year. These financial statements should be read in conjunction with our consolidated financial statements and footnotes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2018 .

Use of estimates

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

Subsequent events

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

Business acquisition

In April 2019, we acquired the homebuilding operations of American West, located in Las Vegas, Nevada, for $ 163.7 million . The assets acquired included approximately  1,200 finished lots and control of approximately  2,300  additional lots through land option agreements. The acquired net assets were recorded at their estimated fair values, including $12.0 million associated with the American West tradename, which is being amortized over a 20 -year life. The acquisition of these assets was not material to our results of operations or financial condition.

Other expense, net

Other expense, net consists of the following ($000’s omitted):  
 
Three Months Ended
 
Six Months Ended
June 30,
 
June 30,
2019
 
2018
 
2019
 
2018
Write-offs of deposits and pre-acquisition costs
$
(2,516
)
 
$
(1,652
)
 
$
(5,433
)
 
$
(4,261
)
Amortization of intangible assets
(3,550
)
 
(3,450
)
 
(7,000
)
 
(6,900
)
Loss on debt retirement (see Note 4 )
(4,843
)
 
(76
)
 
(4,843
)
 
(76
)
Interest income
4,471

 
835

 
9,420

 
1,399

Interest expense
(146
)
 
(165
)
 
(290
)
 
(308
)
Equity in earnings of unconsolidated entities
129

 
265

 
165

 
1,226

Miscellaneous, net
2,956

 
2,287

 
3,508

 
5,657

Total other expense, net
$
(3,499
)
 
$
(1,956
)
 
$
(4,473
)
 
$
(3,263
)



8


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

Revenue recognition

Home sale revenues - Home sale revenues and related profit are generally recognized when title to and possession of the home are transferred to the buyer at the home closing date. Our performance obligation to deliver the agreed-upon home is generally satisfied in less than one year from the original contract date. Home sale contract assets consist of cash from home closings held in escrow for our benefit, typically for less than five days, which are considered deposits in-transit and classified as cash. Contract liabilities include customer deposit liabilities related to sold but undelivered homes, which totaled $334.5 million and $254.6 million at June 30, 2019 and December 31, 2018 , respectively. Substantially all of our home sales are scheduled to close and be recorded to revenue within one year from the date of receiving a customer deposit. See Note 8 for information on warranties and related obligations.

Land sale revenues - 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 sales are generally outright sales of specified land parcels with cash consideration due on the closing date, which is generally when performance obligations are satisfied.

Financial services revenues - 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. Mortgage servicing fees represent fees earned for servicing loans. Servicing fees are based on a contractual percentage of the outstanding principal balance and are credited to income when related mortgage payments are received.

Revenues associated with our title operations are recognized as closing services are rendered and title insurance policies are issued, both of which generally occur as each home is closed. Insurance brokerage commissions relate to commissions on homeowner and other insurance policies placed with third party carriers through various agency channels. Our performance obligations for policy renewal commissions are satisfied upon issuance of the initial policy, and related contract assets for estimated future renewal commissions are included in other assets and totaled $32.4 million at June 30, 2019 .

Earnings per share

Basic earnings per share is computed by dividing income available to common shareholders (the “Numerator”) by the weighted-average number of common shares outstanding, adjusted for unvested shares (the “Denominator”) for the period. Computing diluted earnings per share is similar to computing basic earnings per share, except that the Denominator is increased to include the dilutive effects of stock options, unvested restricted shares, unvested restricted share units, and other potentially dilutive instruments. Any stock options that have an exercise price greater than the average market price are considered to be anti-dilutive and are excluded from the diluted earnings per share calculation.

In accordance with Accounting Standards Codification ("ASC") 260, "Earnings Per Share", the two-class method determines earnings per share for each class of common stock and participating securities according to an earnings allocation formula that adjusts the Numerator for dividends or dividend equivalents and participation rights in undistributed earnings. Unvested share-based payment awards that contain non-forfeitable rights to dividends or dividend equivalents are participating securities and, therefore, are included in computing earnings per share pursuant to the two-class method. Our outstanding restricted share awards, restricted share units, and deferred shares are considered participating securities. The following table presents the earnings per common share (000's omitted, except per share data):

9


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

 
Three Months Ended
 
Six Months Ended
June 30,
 
June 30,
2019
 
2018
 
2019
 
2018
Numerator:
 
 
 
 
 
 
 
Net income
$
241,041

 
$
324,089

 
$
407,798

 
$
494,841

Less: earnings distributed to participating securities
(305
)
 
(300
)
 
(613
)
 
(595
)
Less: undistributed earnings allocated to participating securities
(2,089
)
 
(3,284
)
 
(3,588
)
 
(2,584
)
Numerator for basic earnings per share
$
238,647

 
$
320,505

 
$
403,597

 
$
491,662

Add back: undistributed earnings allocated to participating securities
2,089

 
3,284

 
3,588

 
2,584

Less: undistributed earnings reallocated to participating securities
(2,082
)
 
(3,268
)
 
(3,576
)
 
(2,575
)
Numerator for diluted earnings per share
$
238,654

 
$
320,521

 
$
403,609

 
$
491,671

 
 
 
 
 
 
 
 
Denominator:
 
 
 
 
 
 
 
Basic shares outstanding
276,652

 
285,276

 
277,142

 
285,976

Effect of dilutive securities
932

 
1,378

 
967

 
1,088

Diluted shares outstanding
277,584

 
286,654

 
278,109

 
287,064

 
 
 
 
 
 
 
 
Earnings per share:
 
 
 
 
 
 
 
Basic
$
0.86

 
$
1.12

 
$
1.46

 
$
1.72

Diluted
$
0.86

 
$
1.12

 
$
1.45

 
$
1.71



Residential mortgage loans available-for-sale

Substantially all of the loans originated by us are sold in the secondary mortgage market within a short period of time after origination, generally within 30 days . At June 30, 2019 and December 31, 2018 , residential mortgage loans available-for-sale had an aggregate fair value of $343.7 million and $461.4 million , respectively, and an aggregate outstanding principal balance of $331.9 million and $444.2 million , respectively. The net loss resulting from changes in fair value of these loans totaled $0.2 million for both the three months ended June 30, 2019 and 2018 , and $1.3 million and $0.3 million for the six months ended June 30, 2019 and 2018 , respectively. These changes in fair value were substantially offset by changes in the fair value of corresponding hedging instruments. Net gains from the sale of mortgages were $30.4 million and $29.2 million for the three months ended June 30, 2019 and 2018 , respectively, and $54.3 million and $56.2 million for the six months ended June 30, 2019 and 2018 , respectively, and have been included in Financial Services revenues.

Derivative instruments and hedging activities

We are party to interest rate lock commitments ("IRLCs") with customers resulting from our mortgage origination operations. At June 30, 2019 and December 31, 2018 , we had aggregate IRLCs of $386.0 million and $285.0 million , respectively, which were originated at interest rates prevailing at the date of commitment. Since we can terminate a loan commitment if the borrower does not comply with the terms of the contract, and some loan commitments may expire without being drawn upon, these commitments do not necessarily represent future cash requirements. We evaluate the creditworthiness of these transactions through our normal credit policies.

We hedge our exposure to interest rate market risk relating to residential mortgage loans available-for-sale and IRLCs using forward contracts on mortgage-backed securities, which are commitments to either purchase or sell a specified financial instrument at a specified future date for a specified price, and whole loan investor commitments, which are obligations of an investor to buy loans at a specified price within a specified time period. Forward contracts on mortgage-backed securities are the predominant derivative financial instruments we use to minimize market risk during the period from the time we extend an interest rate lock to a loan applicant until the time the loan is sold to an investor. At June 30, 2019 and December 31, 2018 , we had unexpired forward contracts of $577.0 million and $511.0 million , respectively, and whole loan investor commitments of

10


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

$115.2 million and $187.8 million , respectively. Changes in the fair value of IRLCs and other derivative financial instruments are recognized in Financial Services revenues, and the fair values are reflected in other assets or other liabilities, as applicable.

There are no credit-risk-related contingent features within our derivative agreements, and counterparty risk is considered minimal. Gains and losses on IRLCs and residential mortgage loans available-for-sale are substantially offset by corresponding gains or losses on forward contracts on mortgage-backed securities and whole loan investor commitments. We are generally not exposed to variability in cash flows of derivative instruments for more than approximately 60 days. The fair values of derivative instruments and their locations in the Condensed Consolidated Balance Sheets are summarized below ($000’s omitted):
 
 
June 30, 2019
 
December 31, 2018
 
Other Assets
 
Accrued and Other Liabilities
 
Other Assets
 
Accrued and Other Liabilities
Interest rate lock commitments
$
11,402

 
$
370

 
$
9,196

 
$
161

Forward contracts
188

 
3,920

 
315

 
7,229

Whole loan commitments
709

 
401

 
393

 
1,111

 
$
12,299

 
$
4,691

 
$
9,904

 
$
8,501



New accounting pronouncements

On January 1, 2019, we adopted Accounting Standards Update (“ASU”) No. 2016-02, “Leases (Topic 842)” (“ASU 2016-02”) and related amendments using a modified retrospective approach with an effective date as of January 1, 2019. Prior year financial statements were not required to be recast under the new standard and, therefore, have not been reflected as such on our balance sheet. ASU 2016-02 requires leases with durations greater than 12 months to be recorded on the balance sheet. We elected the package of transition practical expedients, which allowed us to carryforward our historical assessment of (1) whether contracts are or contain leases, (2) lease classification, and (3) initial direct costs. The adoption of ASU 2016-02 had no impact on retained earnings. See Note 8 “Leases” for additional information about this adoption.

On January 1, 2018, we adopted ASC 606, "Revenue from Contracts with Customers", which requires revenue to be recognized in a manner to depict the transfer of goods or services and satisfaction of performance obligations to a customer at an amount that reflects the consideration expected to be received in exchange for those goods or services. We applied the modified retrospective method to contracts that were not completed as of January 1, 2018. Results for reporting periods beginning after January 1, 2018 are presented under ASC 606, while prior period amounts are not adjusted and continue to be reported under the previous accounting standards. We recorded a net increase to opening retained earnings of $22.4 million , net of tax, as of January 1, 2018, due to the cumulative impact of adopting ASC 606, with the impact primarily related to the recognition of contract assets for insurance brokerage commission renewals. There was not a material impact to revenues as a result of applying ASC 606, and there were no significant changes to our business processes, systems, or internal controls as a result of implementing the standard.

In June 2016, the Financial Accounting Standards Board ("FASB") issued ASU No. 2016-13, "Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments", which changes the impairment model for most financial assets and certain other instruments from an "incurred loss" approach to a new "expected credit loss" methodology. The standard is effective for us for annual and interim periods beginning January 1, 2020, with early adoption permitted. We are currently evaluating the impact the standard will have on our financial statements.

In January 2017, the FASB issued ASU No. 2017-04, "Intangibles - Goodwill and Other (Topic 350): Simplifying the Accounting for Goodwill Impairment", which removes the requirement to perform a hypothetical purchase price allocation to measure goodwill impairment. Under the new standard, goodwill impairment will now be determined by evaluating the amount by which a reporting unit’s carrying value exceeds its fair value, not to exceed the carrying amount of goodwill. The standard is effective for us for annual and interim periods beginning January 1, 2020, with early adoption permitted, and applied prospectively. We do not expect the standard to have a material impact on our financial statements.





11


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



2. Inventory

Major components of inventory were as follows ($000’s omitted):  
 
June 30,
2019
 
December 31,
2018
Homes under construction
$
3,120,585

 
$
2,630,158

Land under development
4,229,633

 
4,129,225

Raw land
452,274

 
493,970

 
$
7,802,492

 
$
7,253,353



We capitalize interest cost into inventory during the active development and construction of our communities. In all periods presented, we capitalized all Homebuilding interest costs into inventory because the level of our active inventory exceeded our debt levels. Information related to interest capitalized into inventory is as follows ($000’s omitted):
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2019
 
2018
 
2019
 
2018
Interest in inventory, beginning of period
$
235,313

 
$
240,013

 
$
227,495

 
$
226,611

Interest capitalized
41,650

 
43,771

 
84,031

 
87,731

Interest expensed
(42,254
)
 
(40,157
)
 
(76,817
)
 
(70,715
)
Interest in inventory, end of period
$
234,709

 
$
243,627

 
$
234,709

 
$
243,627



Land option agreements

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

If an entity holding the land under option is a variable interest entity ("VIE"), our deposit represents a variable interest in that entity. No VIEs required consolidation at either June 30, 2019 or December 31, 2018 because we determined that we were not the VIEs' primary beneficiary. Our maximum exposure to loss related to these VIEs is generally limited to our deposits and pre-acquisition costs under the land option agreements.


12


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

The following provides a summary of our interests in land option agreements as of June 30, 2019 and December 31, 2018 ($000’s omitted):
 
 
June 30, 2019
 
December 31, 2018
 
Deposits and
Pre-acquisition
Costs
 
Remaining Purchase
Price
 
Deposits and
Pre-acquisition
Costs
 
Remaining Purchase
Price
Land options with VIEs
$
100,523

 
$
1,109,963

 
$
90,717

 
$
1,079,507

Other land options
154,907

 
1,693,446

 
127,851

 
1,522,903

 
$
255,430

 
$
2,803,409

 
$
218,568

 
$
2,602,410



3. Segment information

Our Homebuilding operations are engaged in the acquisition and development of land primarily for residential purposes within the U.S. and the construction of housing on such land. For reporting purposes, our Homebuilding operations are aggregated into six reportable segments:
Northeast:
 
Connecticut, Maryland, Massachusetts, New Jersey, Pennsylvania, Virginia
Southeast:
 
Georgia, North Carolina, South Carolina, Tennessee
Florida:
 
Florida
Midwest:
 
Illinois, Indiana, Kentucky, Michigan, Minnesota, 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 and operate generally in the same markets as the Homebuilding segments.


13


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

 
Operating Data by Segment
($000’s omitted)
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2019
 
2018
 
2019
 
2018
Revenues:
 
 
 
 
 
 
 
Northeast
$
200,237

 
$
200,626

 
$
310,729

 
$
333,062

Southeast
409,121

 
445,506

 
784,538

 
820,129

Florida
535,153

 
455,637

 
931,597

 
804,346

Midwest
350,584

 
356,466

 
644,174

 
653,972

Texas
342,886

 
330,692

 
611,889

 
577,331

West
595,047

 
728,031

 
1,102,933

 
1,252,273

 
2,433,028

 
2,516,958

 
4,385,860

 
4,441,113

Financial Services
55,957

 
52,764

 
99,819

 
98,702

Consolidated revenues
$
2,488,985

 
$
2,569,722

 
$
4,485,679

 
$
4,539,815

 
 
 
 
 
 
 
 
Income (loss) before income taxes:
 
 
 
 
 
 
 
Northeast
$
26,212

 
$
25,158

 
$
34,140

 
$
34,470

Southeast
42,499

 
54,357

 
80,355

 
94,814

Florida
80,066

 
67,491

 
129,662

 
112,436

Midwest
42,962

 
43,050

 
69,120

 
71,451

Texas
49,144

 
50,859

 
80,115

 
81,395

West (a)
94,443

 
154,414

 
184,625

 
243,619

Other homebuilding (b)
(39,628
)
 
(6,876
)
 
(78,024
)
 
(39,374
)
 
295,698

 
388,453

 
499,993

 
598,811

Financial Services
25,078

 
20,717

 
37,486

 
34,551

Consolidated income before income taxes
$
320,776

 
$
409,170

 
$
537,479

 
$
633,362



(a)
West includes gains of $26.4 million related to two land sale transactions in California that closed in the three months ended June 30, 2018 .
(b)
Other homebuilding includes the amortization of intangible assets and capitalized interest and other items not allocated to the operating segments. Other homebuilding also includes insurance reserve reversals of $12.8 million and $16.6 million for the three and six months ended June 30, 2019 , respectively, and $37.5 million and $35.1 million for the three and six months ended June 30, 2018 , respectively, and write-offs of insurance receivables of $12.6 million and $24.2 million for the three and six months ended June 30, 2019 (see Note 8 ).


14


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

 
Operating Data by Segment
($000’s omitted)
 
 
 
 
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2019
 
2018
 
2019
 
2018
Land-related charges*:
 
 
 
 
 
 
 
Northeast
$
130

 
$
498

 
$
454

 
$
1,683

Southeast
2,015

 
689

 
2,587

 
1,731

Florida
765

 
226

 
1,246

 
409

Midwest
203

 
372

 
1,306

 
1,118

Texas
414

 
220

 
482

 
270

West
216

 
148

 
647

 
361

Other homebuilding
88

 
269

 
88

 
269

 
$
3,831

 
$
2,422

 
$
6,810

 
$
5,841


*
Land-related charges include land impairments, net realizable value adjustments on land held for sale and write-offs of deposits and pre-acquisition costs for land option contracts we elected not to pursue.
 
Operating Data by Segment
 
($000's omitted)
 
June 30, 2019
 
Homes Under
Construction
 
Land Under
Development
 
Raw Land
 
Total
Inventory
 
Total
Assets
Northeast
$
366,441

 
$
259,727

 
$
25,929

 
$
652,097

 
$
745,833

Southeast
493,516

 
671,369

 
82,093

 
1,246,978

 
1,391,938

Florida
537,240

 
886,951

 
73,684

 
1,497,875

 
1,649,747

Midwest
349,951

 
428,841

 
33,779

 
812,571

 
890,008

Texas
353,512

 
447,071

 
98,613

 
899,196

 
966,504

West
966,605

 
1,255,278

 
120,991

 
2,342,874

 
2,590,663

Other homebuilding (a)
53,320

 
280,396

 
17,185

 
350,901

 
1,394,068

 
3,120,585

 
4,229,633

 
452,274

 
7,802,492

 
9,628,761

Financial Services

 

 

 

 
466,776

 
$
3,120,585

 
$
4,229,633

 
$
452,274

 
$
7,802,492

 
$
10,095,537

 
 
 
 
 
 
 
 
 
 


15


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

 
Operating Data by Segment
 
($000's omitted)
 
December 31, 2018
 
Homes Under
Construction
 
Land Under
Development
 
Raw Land
 
Total
Inventory
 
Total
Assets
Northeast
$
268,900

 
$
291,467

 
$
52,245

 
$
612,612

 
$
704,515

Southeast
443,140

 
676,087

 
90,332

 
1,209,559

 
1,347,427

Florida
467,625

 
892,669

 
85,321

 
1,445,615

 
1,601,906

Midwest
314,442

 
433,056

 
29,908

 
777,406

 
849,596

Texas
284,405

 
427,124

 
98,415

 
809,944

 
881,629

West
805,709

 
1,131,841

 
118,579

 
2,056,129

 
2,208,092

Other homebuilding (a)
45,937

 
276,981

 
19,170

 
342,088

 
2,006,825

 
2,630,158

 
4,129,225

 
493,970

 
7,253,353

 
9,599,990

Financial Services

 

 

 

 
572,986

 
$
2,630,158

 
$
4,129,225

 
$
493,970

 
$
7,253,353

 
$
10,172,976


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

4. Debt

Notes payable

Our senior notes are summarized as follows ($000’s omitted):
 
June 30,
2019
 
December 31,
2018
4.250% unsecured senior notes due March 2021 (a)
$
425,954

 
$
700,000

5.500% unsecured senior notes due March 2026 (a)
700,000

 
700,000

5.000% unsecured senior notes due January 2027 (a)
600,000

 
600,000

7.875% unsecured senior notes due June 2032 (a)
300,000

 
300,000

6.375% unsecured senior notes due May 2033 (a)
400,000

 
400,000

6.000% unsecured senior notes due February 2035 (a)
300,000

 
300,000

Net premiums, discounts, and issuance costs (b)
(14,567
)
 
(13,247
)
Total senior notes
2,711,387

 
2,986,753

Other notes payable
28,938

 
41,313

Notes payable
$
2,740,325

 
$
3,028,066

Estimated fair value
$
2,942,710

 
$
2,899,143



(a)
Redeemable prior to maturity; guaranteed on a senior basis by certain wholly-owned subsidiaries
(b)
The carrying value of senior notes reflects the impact of premiums, discounts, and issuance costs that are amortized to interest cost over the respective terms of the senior notes.

Other notes payable include non-recourse and limited recourse collateralized notes with third parties that totaled $28.9 million and $41.3 million at June 30, 2019 and December 31, 2018 , respectively. These notes have maturities ranging up to three years , are secured by the applicable land positions to which they relate, and have no recourse to any other assets. The stated interest rates on these notes range up to 8% .

16


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


During the three months ended June 30, 2019 , we retired $274.0 million of our unsecured senior notes maturing in 2021 through a previously announced cash tender offer. The retirement resulted in a loss of $4.8 million , which includes the write-off of debt issuance costs, unamortized discounts and premiums, and transaction fees related to the repurchased debt, and is reflected in other expense, net.

Revolving credit facility

In June 2018, we entered into the Second Amended and Restated Credit Agreement ("Revolving Credit Facility") which replaced the Company's previous credit agreement. The Revolving Credit Facility contains substantially similar terms to the previous credit agreement and extended the maturity date from June 2019 to June 2023. The Revolving Credit Facility has a maximum borrowing capacity of $1.0 billion and contains an uncommitted accordion feature that could increase the capacity to $1.5 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 the available borrowing capacity under the Revolving Credit Facility, with a sublimit of $500.0 million at June 30, 2019 . The interest rate on borrowings under the Revolving Credit Facility may be based on either the London Interbank Offered Rate ("LIBOR") or a base rate plus an applicable margin, as defined therein. We had no borrowings outstanding at June 30, 2019 and December 31, 2018 , and $253.6 million and $239.4 million of letters of credit issued under the Revolving Credit Facility at June 30, 2019 and December 31, 2018 , respectively.

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 June 30, 2019 , we were in compliance with all covenants. Our available and unused borrowings
under the Revolving Credit Facility, net of outstanding letters of credit, amounted to $746.4 million and $760.6 million at June 30, 2019 and December 31, 2018 , respectively.

Joint venture debt

At June 30, 2019 , aggregate outstanding debt of unconsolidated joint ventures was $29.2 million , of which $28.4 million was related to one joint venture in which we have a 50% interest. In connection with this loan, we and our joint venture partner provided customary limited recourse guaranties under which our maximum financial loss exposure is limited to our pro rata share of the debt outstanding. The limited guaranties include, but are not limited to: (i) completion of certain aspects of the project, (ii) an environmental indemnity provided to the lender, and (iii) an indemnification of the lender from certain "bad boy acts" of the joint venture.

Financial Services debt

Pulte Mortgage maintains a master repurchase agreement (the "Repurchase Agreement") with third party lenders that matures in August 2019 . The maximum aggregate commitment was $280.0 million at June 30, 2019 and was reduced to $235.0 million on July 15, 2019. 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 $234.2 million and $348.4 million outstanding under the Repurchase Agreement at June 30, 2019 and December 31, 2018 , respectively, and was in compliance with all of its covenants and requirements as of such dates.

5. Shareholders’ equity

During the six months ended June 30, 2019 , we declared cash dividends totaling $61.5 million and repurchased 3.5 million shares under our repurchase authorization for $108.5 million . For the six months ended June 30, 2018 , we declared cash dividends totaling $52.0 million and repurchased 3.5 million shares under our repurchase authorization for $105.1 million . In May 2019, our board of directors approved a $500.0 million increase in our share repurchase authorization. At June 30, 2019 , we had remaining authorization to repurchase $691.4 million of common shares.

Under our share-based compensation plans, we accept shares as payment under certain conditions related to stock option exercises and vesting of shares, generally related to the payment of minimum tax obligations. During the six months ended June 30, 2019 and 2018 , participants surrendered shares valued at $10.4 million and $7.4 million , respectively, under these plans. Such share transactions are excluded from the above noted share repurchase authorization.

17


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


6. Income taxes

Our effective tax rate for the three and six months ended June 30, 2019 was 24.9% and 24.1% , respectively, compared to 20.8% and 21.9% , respectively, for the same periods in 2018 . Our effective tax rate for the three and six months ended June 30, 2019 differs from the federal statutory rate primarily due to state income tax expense on current year earnings and tax benefits for equity compensation. For the same periods in the prior year, our effective tax rate differed from the federal statutory rate primarily due to state income tax expense on current year earnings, tax benefits due to Internal Revenue Service acceptance in 2018 of an accounting method change applicable to the 2017 tax year, energy credits, and tax law changes.

At June 30, 2019 and December 31, 2018 , we had deferred tax assets, net of deferred tax liabilities and valuation allowance, of $224.1 million and $275.6 million , respectively. The accounting for deferred taxes is based upon estimates of future results. Differences between estimated and actual results could result in changes in the valuation of deferred tax assets that could have a material impact on our consolidated results of operations or financial position. Changes in existing tax laws could also affect actual tax results and the realization of deferred tax assets over time.

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 had $22.4 million and $30.6 million of gross unrecognized tax benefits at June 30, 2019 and December 31, 2018 , respectively. Additionally, we had accrued interest and penalties of $6.0 million and $5.8 million at June 30, 2019 and December 31, 2018 , respectively. It is reasonably possible within the next twelve months that our gross unrecognized tax benefits may decrease by up to $8.4 million , excluding interest and penalties, primarily due to potential audit settlements.

7. Fair value disclosures

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

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

18


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

Financial Instrument
 
Fair Value
Hierarchy
 
Fair Value
June 30,
2019
 
December 31,
2018
 
 
 
 
 
 
 
Measured at fair value on a recurring basis:
 
 
 
 
 
 
Residential mortgage loans available-for-sale
 
Level 2
 
$
343,732

 
$
461,354

Interest rate lock commitments
 
Level 2
 
11,032

 
9,035

Forward contracts
 
Level 2
 
(3,732
)
 
(6,914
)
Whole loan commitments
 
Level 2
 
308

 
(718
)
 
 
 
 
 
 
 
Measured at fair value on a non-recurring basis:
 
 
 
 
 
 
House and land inventory
 
Level 3
 
$

 
$
18,253

Land held for sale
 
Level 2
 
6,185

 
17,813

 
 
 
 
 
 
 
Disclosed at fair value:
 
 
 
 
 
 
Cash, cash equivalents, and restricted cash
 
Level 1
 
$
659,274

 
$
1,133,700

Financial Services debt
 
Level 2
 
234,186

 
348,412

Senior notes payable
 
Level 2
 
2,913,772

 
2,857,830

Other notes payable
 
Level 2
 
28,938

 
41,313



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

Certain assets are required to be recorded at fair value on a non-recurring basis when events and circumstances indicate that the carrying value may not be recoverable. The non-recurring fair values included in the above table represent only those assets whose carrying values were adjusted to fair value as of the respective balance sheet dates.

The carrying amounts of cash and equivalents, Financial Services debt, and other notes payable approximate their fair values due to their short-term nature and/or floating interest rate terms. The fair values of senior notes are based on quoted market prices, when available. If quoted market prices are not available, fair values are based on quoted market prices of similar issues. The carrying value of senior notes was $2.7 billion and $3.0 billion at June 30, 2019 and December 31, 2018 , respectively.

8. Commitments and contingencies

Loan origination liabilities

Our mortgage operations may be responsible for losses associated with mortgage loans originated and sold to investors in the event of errors or omissions relating to representations and warranties made by us that the loans met certain requirements, including representations as to underwriting standards, the existence of primary mortgage insurance, and the validity of certain borrower representations in connection with the loan. In addition, certain trustees and investors continue to attempt to collect damages based on losses from loans that originated prior to 2009. Some of our mortgage subsidiaries are currently defendants in litigation related to such claims. If a loan is determined to be faulty, we either indemnify the investor for potential future losses, repurchase the loan from the investor, or reimburse the investor's actual losses.

CTX Mortgage Company, LLC ("CTX Mortgage") was the mortgage subsidiary of Centex and ceased originating loans in December 2009. In the matter Lehman Brothers Holdings, Inc. ("Lehman") in the U.S. Bankruptcy Court in the Southern

19


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

District of New York, Lehman has initiated an adversary proceeding against CTX Mortgage seeking indemnity for loans sold to it by CTX Mortgage prior to 2009. This claim is part of a broader action by Lehman in U.S. Bankruptcy Court against more than 100 mortgage originators and brokers. On August 13, 2018, the court denied a motion to dismiss filed by CTX Mortgage and other defendants, and on December 17, 2018, Lehman filed an amended adversary complaint against CTX Mortgage. Lehman's complaint alleges claims for indemnifiable losses of up to $261 million due from CTX Mortgage. We believe that CTX Mortgage has meritorious defenses and CTX Mortgage will continue to vigorously defend itself in this matter. We have recorded a liability for an amount that we consider to be the best estimate within a range of potential losses.

In addition, both CTX Mortgage and Pulte Mortgage sold certain loans originated prior to 2009 to financial institutions that were subsequently included in residential mortgage-backed securities or other securitizations issued by such financial institutions. In connection with such sales, CTX Mortgage and Pulte Mortgage have been put on notice of potential direct and / or third-party claims for indemnification arising out of litigation relating to certain of these residential mortgage-backed securities or other securitizations and, in some instances, such claims have resulted in legal proceedings against CTX Mortgage or Pulte Mortgage. We cannot yet quantify CTX Mortgage's or Pulte Mortgage's potential liability as a result of these indemnification claims. We do not believe, however, that these matters will have a material adverse impact on the results of operations, financial position, or cash flows of the Company.

Our recorded liabilities for all such claims decreased from $50.3 million at December 31, 2018 to $25.5 million at June 30, 2019 as the result of funding previously settled claims. Determining the liabilities for anticipated losses requires a significant level of management judgment. Given the nature of these claims and the uncertainty regarding their ultimate resolution, actual costs could differ from our current estimates.

Letters of credit and surety bonds

In the normal course of business, we post letters of credit and surety bonds pursuant to certain performance-related obligations, as security for certain land option agreements, and under various insurance programs. The majority of these letters of credit and surety bonds are in support of our land development and construction obligations to various municipalities, other government agencies, and utility companies related to the construction of roads, sewers, and other infrastructure. We had outstanding letters of credit and surety bonds totaling $253.6 million and $1.3 billion , respectively, at June 30, 2019 and $239.4 million and $1.3 billion , respectively, at December 31, 2018 . In the event any such letter of credit or surety bond is drawn, we would be obligated to reimburse the issuer of the letter of credit or surety bond. Our surety bonds generally do not have stated expiration dates; rather we are released from the surety bonds as the underlying contractual performance is completed. Because significant construction and development work has been performed related to projects that have 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. We do not believe that a material amount, if any, of the letters of credit or surety bonds will be drawn.

Litigation and regulatory matters

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

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


20


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

Product warranty

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 and, in limited instances, exceeding 10 years. We estimate the costs to be incurred under these warranties and record liabilities in the amount of such costs at the time product revenue is recognized. Factors that affect our warranty liabilities include the number of homes sold, historical and anticipated rates of warranty claims, and the cost per claim. We periodically assess the adequacy of the warranty liabilities for each geographic market in which we operate and adjust the amounts as necessary. Actual warranty costs in the future could differ from the current estimates. Changes to warranty liabilities were as follows ($000’s omitted):
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2019
 
2018
 
2019
 
2018
Warranty liabilities, beginning of period
$
79,747

 
$
70,986

 
$
79,154

 
$
72,709

Reserves provided
14,646

 
15,731

 
26,908

 
27,647

Payments
(17,931
)
 
(17,129
)
 
(34,061
)
 
(31,411
)
Other adjustments
4,980

 
2,581

 
9,441

 
3,224

Warranty liabilities, end of period
$
81,442

 
$
72,169

 
$
81,442

 
$
72,169



Self-insured risks

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

Our general liability insurance includes coverage for certain construction defects. While construction defect claims can relate to a variety of circumstances, the majority of our claims relate to alleged problems with siding, plumbing, foundations and other concrete work, windows, roofing, and heating, ventilation and air conditioning systems. The availability of general liability insurance for the homebuilding industry and its subcontractors has become increasingly limited, and the insurance policies available require us to maintain significant per occurrence and aggregate retention levels. In certain instances, we may offer our subcontractors the opportunity to purchase insurance through one of our captive insurance subsidiaries or participate in a project-specific insurance program provided by us. Policies issued by our captive insurance subsidiaries represent self-insurance of these risks by us. This self-insured exposure is limited by reinsurance policies that we purchase. General liability coverage for the homebuilding industry is complex, and our coverage varies from policy year to policy year. Our insurance coverage requires a per occurrence deductible up to an overall aggregate retention level. Beginning with the first dollar, amounts paid to satisfy insured claims generally apply to our per occurrence and aggregate retention obligations. Any amounts incurred in excess of the occurrence or aggregate retention levels are covered by insurance up to our purchased coverage levels. Our insurance policies, including the captive insurance subsidiaries' reinsurance policies, are maintained with highly-rated underwriters for whom we believe counterparty default risk is not significant.

At any point in time, we are managing over 1,000 individual claims related to general liability, property, errors and omissions, workers' compensation, and other business insurance coverage. We reserve for costs associated with such claims (including expected claims management expenses) on an undiscounted basis at the time revenue is recognized for each home closing and evaluate the recorded liabilities based on actuarial analyses of our historical claims. The actuarial analyses calculate estimates of the ultimate net cost of all unpaid losses, including estimates for incurred but not reported losses ("IBNR"). IBNR represents losses related to claims incurred but not yet reported plus development on reported claims.

Our recorded reserves for all such claims totaled $716.2 million and $737.0 million at June 30, 2019 and December 31, 2018 , 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 68% and 65% of the total general liability reserves at June 30, 2019 and December 31, 2018 , respectively. The actuarial analyses that determine the IBNR portion of reserves consider a

21


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

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.

Housing market conditions can be volatile, 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 typically 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. We reduced general liability reserves by $16.6 million and $35.1 million during the six months ended June 30, 2019 and June 30, 2018 , respectively. These reductions were primarily the result of changes in estimates driven by claim experience being less than anticipated in previous actuarial projections. The changes in actuarial estimates did not involve any changes in actuarial methodology but did impact the development of estimates for future periods, which resulted in adjustments to the IBNR portion of our recorded liabilities.

Costs associated with our insurance programs are classified within selling, general, and administrative expenses. Change