PULTEGROUP INC/MI/ 10-Q

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations The following discussion and analysis of our financial condition and results of operations are provided as a supplement to and should be read in conjunction with the consolidated financial statements and related notes included elsewhere in this Quarterly Report on Form 10-Q as well as our audited consolidated financial statements and related notes included in our Annual Report on Form 10-K for the year ended December 31, 2021. Our home sales revenues increased 16% and 17% for the three and nine months ended September 30, 2022 over the comparable prior year periods, respectively, while our gross margins increased 360 bps and 390 bps, respectively, over the same periods. These results were driven by increases in selling prices in response to robust consumer demand in 2021 and early 2022 when the majority of the homes closed in the three and nine months ended September 30, 2022 were placed under contract with the customers. However, the strength of new home demand has progressively declined during 2022 as the Federal Reserve increased benchmark interest rates in response to inflation, which, in turn, drove national mortgage and other interest rates higher, impacting home affordability and consumer sentiment. These increases in interest rates, along with ongoing high inflation, disruptions related to the conflict in Ukraine, and other macroeconomic factors, have tempered new home demand in all of our markets. As a result, net new orders declined 28% and 23% in the three and nine months ended September 30, 2022, respectively, compared with the prior year periods. Our order backlog at September 30, 2022 remained high relative to historical levels, but decreased 11% and 5% in units from June 30, 2022 and December 31, 2021, respectively. These decreases in backlog were driven by the aforementioned lower new orders, combined with an increasing cancellation rate, which increased to 24% in the three months ended September 30, 2022, compared to 10% in the comparable prior year period. Supply chain constraints that began after the onset of the COVID-19 pandemic have continued to limit the availability of certain materials and construction labor, which, combined with delays in municipal approvals and inspections, continue to pressure production cycle times of the homes we are constructing. The time required to construct a home was approximately seven weeks longer in the third quarter of 2022 as compared with the prior year period and approximately one week longer than the second quarter of 2022. The noted supply chain and labor issues have led to significant cost pressures in almost all areas of our business, but especially related to construction labor and materials. In 2021 and the first half of 2022, we were able to increase pricing to offset the majority of such cost increases, but pricing will be significantly more challenged in the near term given the lower demand for new homes. In response to the significant shift in market conditions in 2022, we have slowed the pace of our housing starts, have increased sales incentives, and are taking additional pricing actions in many of our communities. We are updating the underwriting for each of our land option contracts prior to buying additional land and have recently made decisions to walk away from a number of land option agreements, which resulted in write-offs of deposits and pre-acquisition costs totaling $24.5 million in the three months ended September 30, 2022. We will be working with our trade partners to update the costs for materials, labor, and services to reflect current market conditions and will adjust our overhead cost structure as necessary to align with demand. We expect that the more challenging environment for new residential housing will continue through at least 2023 and will result in lower revenues and profitability during those periods. Despite these conditions, there remains a housing shortage across the United States, and we are confident in our ability to navigate this environment and to position the Company to take advantage of opportunities as they arise. 23 Consolidated Operations The following is a summary of our operating results by line of business ($000's omitted, except per share data): Three Months Ended Nine Months Ended September 30, September 30, 2022 2021 2022 2021 Income before income taxes: Homebuilding $ 783,763 $ 571,763 $ 2,167,562 $ 1,487,486 Financial Services 27,514 48,639 108,181 166,442 Income before income taxes 811,277 620,402 2,275,743 1,653,928 Income tax expense (183,349) (144,853) (540,657) (370,873) Net income $ 627,928 $ 475,549 $ 1,735,086 $ 1,283,055 Per share data - assuming dilution: Net income $ 2.69 $ 1.82 $ 7.22 $ 4.85 • Homebuilding income before income taxes in the three and nine months ended September 30, 2022 increased 37% and 46% compared with the same periods in 2021, respectively. The results are primarily the result of a significantly higher average selling price and gross margin partially offset by higher write-offs of land deposits and pre-acquisition costs. Results for the nine months ended September 30, 2021 also include insurance reserve reversals of $56.6 million and a loss on debt retirement of $61.5 million (see Note 8 and Note 4 , respectively). • Financial Services income before income taxes in the three and nine months ended September 30, 2022 decreased 43% and 35% compared to the same periods in 2021, respectively, primarily as the result of a lower capture rate and revenue per loan due to increased competitiveness in the mortgage industry in 2022. • Our effective tax rate in the three and nine months ended September 30, 2022 was 22.6% and 23.8%, respectively, compared to 23.3% and 22.4%, respectively, for the same periods in 2021. Our effective tax rate for each of these periods differs from the federal statutory rate primarily due to state income tax expense and benefits associated with federal energy efficient home credits, while the 2021 tax rate also included a benefit associated with a reduction in valuation allowances relating to projected utilization of certain state net operating loss carryforwards. 24 Homebuilding Operations The following presents selected financial information for our Homebuilding operations ($000’s omitted): Three Months Ended Nine Months Ended September 30, September 30, 2022 2022 vs. 2021 2021 2022 2022 vs. 2021 2021 Home sale revenues $ 3,840,449 16 % $ 3,324,483 $ 10,720,364 17 % $ 9,156,371 Land sale and other revenues 30,658 (51) % 63,085 97,626 (21) % 123,321 Total Homebuilding revenues 3,871,107 14 % 3,387,568 10,817,990 17 % 9,279,692 Home sale cost of revenues (a) (2,685,596) 10 % (2,443,074) (7,498,027) 11 % (6,754,204) Land sale and other cost of revenues (26,314) (45) % (47,483) (89,971) (13) % (103,313) Selling, general, and administrative expenses ("SG&A") (b) (350,112) 9 % (320,506) (1,030,391) 19 % (864,478) Loss on debt retirement — — % — — (c) (61,469) Other expense, net (25,322) 434 % (4,742) (32,039) 266 % (8,742) Income before income taxes $ 783,763 37 % $ 571,763 $ 2,167,562 46 % $ 1,487,486 Supplemental data: Gross margin from home sales 30.1 % 360 bps 26.5 % 30.1 % 390 bps 26.2 % SG&A as a percentage of home sale revenues 9.1 % (50) bps 9.6 % 9.6 % 20 bps 9.4 % Closings (units) 7,047 1 % 7,007 20,263 — % 20,283 Average selling price $ 545 15 % $ 474 $ 529 17 % $ 451 Net new orders (d) : Units 4,924 (28) % 6,796 19,313 (23) % 24,970 Dollars $ 2,807,308 (26) % $ 3,780,354 $ 11,442,579 (10) % $ 12,668,805 Cancellation rate 24 % 10 % 15 % 8 % Average active communities 823 7 % 768 797 (1) % 804 Backlog at September 30: Units 17,053 (14) % 19,845 Dollars $ 10,581,026 3 % $ 10,305,614 (a) Includes the amortization of capitalized interest. (b) Includes insurance reserve reversals of $56.6 million for the nine months ended September 30, 2021, (see Note 8 ). (c) Percentage not meaningful. (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 in the three and nine months ended September 30, 2022 were higher than the prior year periods by $516.0 million and $1.6 billion, respectively. In the three months ended September 30, 2022, the 16% increase resulted from a 15% increase in average selling price combined with a 1% increase in closings. In the nine months ended September 30, 2022, the 17% increase resulted from a 17% increase in average selling price. The increases in average selling price reflected the impact of pricing actions taken in response to robust consumer demand in 2021 and early 2022 when the majority of the homes that closed were placed under contract with the customers, partially offset by an increase in the mix of first-time buyer homes, which typically carry a lower sales price. The year-over-year increases in average selling price occurred in substantially all of our markets. 25 Home sale gross margins Home sale gross margins were 30.1% in both the three and nine months ended September 30, 2022, compared to 26.5% and 26.2% in the three and nine months ended September 30, 2021, respectively. Gross margins reflected the robust consumer demand that existed in 2021 and early 2022 when the majority of the homes that closed were placed under contract with the customers combined with limited supplies of new and existing housing inventory. This resulted in a strong pricing environment, which allowed us to offset increases in house and land costs through pricing actions in the three and nine months ended September 30, 2022. Land sale and other 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 sale and other revenues and their related gains or losses vary between periods, depending on the timing of land sales and our strategic operating decisions. Land sales and other revenues contributed income of $4.3 million and $7.7 million for the three and nine months ended September 30, 2022, respectively, compared to $15.6 million and $20.0 million for the three and nine months ended September 30, 2021, respectively. Income in the three and nine months ended September 30, 2021 included a gain of $12.9 million related to a land sale transaction in California that had been in the entitlement process for a number of years. SG&A SG&A as a percentage of home sale revenues was 9.1% and 9.6% in the three and nine months ended September 30, 2022, respectively, compared with 9.6% and 9.4% for the three and nine months ended September 30, 2021, respectively. The gross dollar amount of our SG&A increased $29.6 million, or 9%, for the three months ended September 30, 2022 compared to the prior year period, and increased $165.9 million, or 19%, for the nine months ended September 30, 2022 compared to the prior year period. The increases in gross dollars in 2022 resulted primarily from higher headcount and other overhead costs to support growth expectations and the increased number of homes in production, combined with insurance reserve reversals of $56.6 million recorded in the nine months ended September 30, 2021 (see Note 8 ). Other expense, net Other expense, net includes the following ($000’s omitted): Three Months Ended Nine Months Ended September 30, September 30, 2022 2021 2022 2021 Write-offs of deposits and pre-acquisition costs $ (24,462) $ (3,567) $ (32,475) $ (6,801) Amortization of intangible assets (2,766) (3,612) (8,353) (13,571) Interest income 370 436 1,048 1,541 Interest expense (65) (115) (216) (387) Equity in earnings of unconsolidated entities 446 604 2,390 5,620 Miscellaneous, net 1,155 1,512 5,567 4,856 Total other expense, net $ (25,322) $ (4,742) $ (32,039) $ (8,742) Net new orders Net new orders in units decreased 28% while net new orders in dollars decreased 26% in the three months ended September 30, 2022, as compared to the prior year period. Net new orders in units decreased 23% while net new orders in dollars decreased 10% for the nine months ended September 30, 2022 as compared with the prior year period. The decreases in net new order volume in 2022 are due primarily to reduced buyer demand, which began in the second quarter of 2022, particularly for homes that are estimated to close further out in time, as the market responded to increased affordability challenges resulting from a historic increase in mortgage interest rates, increases in the price of homes, and the impact of inflationary pressures in the broader economy. Contributing factors also include our lower average community count and Company actions to intentionally moderate sales pace earlier in 2022 in order to manage our large backlog of orders and supply chain challenges. The cancellation rate (canceled orders for the period divided by gross new orders for the period) was 24% and 15% for the three and nine months ended September 30, 2022, respectively, and 10% and 8% for the comparable periods in 2021, respectively. The 26 increase in cancellation rate occurred primarily in the second and third quarters of 2022 due to a decrease in consumer confidence coupled with the aforementioned increases in mortgage interest rates. Ending backlog dollars, which represents orders for homes that have not yet closed, increased 3% at September 30, 2022 compared with September 30, 2021, as the result of higher average selling prices and elongated production cycle times, partially offset by lower net new orders. Homes in production The following is a summary of our homes in production: September 30, 2022 September 30, 2021 Sold 14,854 15,676 Unsold Under construction 7,656 3,017 Completed 500 109 8,156 3,126 Models 1,272 1,212 Total 24,282 20,014 The number of homes in production at September 30, 2022 was 21% higher than at September 30, 2021. This increase is primarily attributable to a higher level of unsold homes, or speculative homes, under construction, which reflects our strategic decision to increase housing starts of speculative units in response to the noted supply chain challenges and to have product available that can close quickly for customers that are concerned about potentially higher mortgage interest rates. The higher cancellation rate in the three months ended September 30, 2022 also contributed to the increase in unsold inventory. Controlled lots The following is a summary of our lots under control at September 30, 2022 and December 31, 2021: September 30, 2022 December 31, 2021 Owned Optioned Controlled Owned Optioned Controlled Northeast 4,661 7,773 12,434 4,422 7,637 12,059 Southeast 17,106 27,929 45,035 15,604 28,887 44,491 Florida 28,989 33,625 62,614 27,654 32,240 59,894 Midwest 13,982 14,505 28,487 11,723 17,118 28,841 Texas 20,777 18,683 39,460 20,538 21,235 41,773 West 29,320 14,312 43,632 29,137 12,101 41,238 Total 114,835 116,827 231,662 109,078 119,218 228,296 50 % 50 % 100 % 48 % 52 % 100 % Developed (%) 41 % 15 % 28 % 38 % 13 % 25 % While competition for well-positioned land is robust, we continue to pursue land investments that we believe can achieve appropriate risk-adjusted returns on invested capital. We also continue to seek to maintain a high percentage of our lots that are controlled via land option agreements, as such contracts enable us to defer acquiring properties until we have determined whether and when to exercise our option, which reduces our financial risks associated with long-term land holdings. However, the percentage of lots controlled via land option agreements decreased in the three months ended September 30, 2022 as the result of our decision to terminate a number of pending transactions. The remaining purchase price under our land option agreements totaled $6.0 billion at September 30, 2022. 27 Homebuilding Segment Operations As of September 30, 2022, we conducted our operations in over 40 markets located throughout 24 states. 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, Colorado, Nevada, New Mexico, Washington The following tables present selected financial information for our reportable Homebuilding segments: Operating Data by Segment ($000's omitted) Three Months Ended Nine Months Ended September 30, September 30, 2022 2022 vs. 2021 2021 2022 2022 vs. 2021 2021 Home sale revenues: Northeast $ 252,760 (7) % $ 273,206 $ 665,488 (10) % $ 735,418 Southeast 718,506 22 % 587,292 1,833,501 19 % 1,539,928 Florida 931,369 32 % 707,990 2,637,919 27 % 2,072,344 Midwest 562,373 12 % 504,273 1,566,379 18 % 1,332,407 Texas 584,825 42 % 412,201 1,598,873 27 % 1,255,377 West 790,616 (6) % 839,521 2,418,204 9 % 2,220,897 $ 3,840,449 16 % $ 3,324,483 $ 10,720,364 17 % $ 9,156,371 Income (loss) before income taxes (a) : Northeast $ 52,682 (1) % $ 53,410 $ 140,052 6 % $ 132,604 Southeast 181,667 66 % 109,407 460,056 68 % 274,174 Florida 220,850 65 % 133,642 628,979 64 % 382,682 Midwest 79,168 9 % 72,537 230,419 17 % 196,205 Texas 133,404 88 % 71,062 351,253 59 % 221,099 West 149,001 (14) % 173,137 468,873 16 % 403,039 Other homebuilding (b) (33,009) 20 % (41,432) (112,070) 8 % (122,317) $ 783,763 37 % $ 571,763 $ 2,167,562 46 % $ 1,487,486 (a) Includes land-related charges as summarized in the table below. (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 $56.6 million and a loss on debt retirement of $61.5 million in the nine months ended September 30, 2021 (see Note 8 and Note 4 , respectively). 28 Operating Data by Segment ($000's omitted) Three Months Ended Nine Months Ended September 30, September 30, 2022 2022 vs. 2021 2021 2022 2022 vs. 2021 2021 Closings (units): Northeast 378 (20) % 472 1,026 (20) % 1,286 Southeast 1,295 1 % 1,278 3,406 (3) % 3,507 Florida 1,628 8 % 1,502 4,840 5 % 4,614 Midwest 1,104 (2) % 1,123 3,179 6 % 3,004 Texas 1,431 12 % 1,276 4,124 3 % 4,020 West 1,211 (11) % 1,356 3,688 (4) % 3,852 7,047 1 % 7,007 20,263 — % 20,283 Average selling price: Northeast $ 669 16 % $ 579 $ 649 13 % $ 572 Southeast 555 21 % 460 538 23 % 439 Florida 572 21 % 471 545 21 % 449 Midwest 509 13 % 449 493 11 % 444 Texas 409 27 % 323 388 24 % 312 West 653 5 % 619 656 14 % 577 $ 545 15 % $ 474 $ 529 17 % $ 451 Net new orders - units: Northeast 237 (36) % 368 1,046 (28) % 1,451 Southeast 1,081 — % 1,085 3,716 (7) % 4,010 Florida 1,471 (20) % 1,844 4,898 (24) % 6,451 Midwest 655 (39) % 1,075 2,660 (32) % 3,936 Texas 979 (12) % 1,117 3,718 (17) % 4,468 West 501 (62) % 1,307 3,275 (30) % 4,654 4,924 (28) % 6,796 19,313 (23) % 24,970 Net new orders - dollars: Northeast $ 165,018 (25) % $ 221,016 $ 736,434 (15) % $ 864,079 Southeast 599,621 2 % 588,400 2,130,969 8 % 1,966,434 Florida 911,099 (13) % 1,043,871 3,188,807 (4) % 3,308,173 Midwest 364,849 (32) % 538,621 1,442,207 (22) % 1,856,704 Texas 385,634 (17) % 463,727 1,551,534 (6) % 1,655,023 West 381,087 (59) % 924,719 2,392,628 (21) % 3,018,392 $ 2,807,308 (26) % $ 3,780,354 $ 11,442,579 (10) % $ 12,668,805 29 Operating Data by Segment ($000's omitted) Three Months Ended Nine Months Ended September 30, September 30, 2022 2021 2022 2022 vs. 2021 2021 Cancellation rates: Northeast 13 % 9 % 9 % 7 % Southeast 15 % 6 % 9 % 6 % Florida 18 % 8 % 13 % 7 % Midwest 14 % 7 % 11 % 6 % Texas 33 % 16 % 22 % 12 % West 48 % 13 % 23 % 11 % 24 % 10 % 15 % 8 % Unit backlog: Northeast 808 (28) % 1,118 Southeast 2,786 (2) % 2,843 Florida 5,488 — % 5,491 Midwest 2,169 (31) % 3,131 Texas 2,693 (23) % 3,501 West 3,109 (17) % 3,761 17,053 (14) % 19,845 Backlog dollars: Northeast $ 582,178 (16) % $ 689,984 Southeast 1,660,331 14 % 1,457,415 Florida 3,608,719 26 % 2,863,695 Midwest 1,223,984 (19) % 1,514,932 Texas 1,254,262 (9) % 1,380,737 West 2,251,552 (6) % 2,398,851 $ 10,581,026 3 % $ 10,305,614 30 Operating Data by Segment ($000’s omitted) Three Months Ended Nine Months Ended September 30, September 30, 2022 2021 2022 2021 Land-related charges (a) : Northeast $ 3,759 $ 223 $ 3,961 $ 357 Southeast 5,889 1,915 9,724 3,253 Florida 4,881 209 6,493 642 Midwest 1,677 477 2,780 969 Texas 2,794 141 3,328 932 West 5,462 602 6,189 667 Other homebuilding — — — — $ 24,462 $ 3,567 $ 32,475 $ 6,820 (a) Land-related charges include land inventory 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. Northeast For the third quarter of 2022, Northeast home sale revenues decreased by 7% when compared with the prior year period due to a 20% decrease in closings partially offset by a 16% increase in average selling price. The decrease in closings and increase in average selling price occurred across all markets. Income before income taxes decreased 1% primarily due to the decrease in closings partially offset by increased average selling price and higher gross margins across the majority of markets. Net new orders decreased across all markets. For the nine months ended September 30, 2022, Northeast home sale revenues decreased by 10% when compared with the prior year period due to a 20% decrease in closings partially offset by a 13% increase in average selling price. The decrease in closings was primarily due to the timing of projects in our Mid-Atlantic operations, while the increase in average selling price occurred across all markets. Income before income taxes increased 6% primarily due to higher gross margins across the majority of markets. Net new orders decreased across all markets. Southeast For the third quarter of 2022, Southeast home sale revenues increased 22% when compared with the prior year period due to a 21% increase in average selling price combined with a 1% increase in closings. The increase in average selling price occurred across all markets while the increase in closings occurred across the majority of markets. Income before income taxes increased 66% primarily due to increased revenues, as well as improved gross margins across all markets. The decrease in net new orders was mixed among markets. For the nine months ended September 30, 2022, Southeast home sale revenues increased 19% when compared with the prior year period due to a 23% increase in average selling price partially offset by a 3% decrease in closings. The increase in average selling price occurred across all markets while the decrease in closings occurred across the majority of markets. Income before income taxes increased 68% primarily due to increased revenues, as well as improved gross margins across all markets. Net new orders decreased across the majority of markets. Florida For the third quarter of 2022, Florida home sale revenues increased 32% when compared with the prior year period due to a 21% increase in average selling price combined with an 8% increase in closings. The increase in average selling price occurred across all markets, while the increase in closings occurred across the majority of markets. Income before income taxes increased 65% primarily due to increased revenues, as well as improved gross margins across all markets. Net new orders decreased across the majority of markets. 31 For the nine months ended September 30, 2022, Florida home sale revenues increased 27% when compared with the prior year period due to a 5% increase in closings combined with a 21% increase in the average selling price. The increase in closings occurred across the majority of markets while the increase in average selling price occurred across all markets. Income before income taxes increased 64% primarily due to increased revenues, as well as improved gross margins across all markets. Net new orders decreased across the majority of markets. Midwest For the third quarter of 2022, Midwest home sale revenues increased 12% when compared with the prior year period due to a 13% increase in average selling price partially offset by a 2% decrease in closings. The increase in average selling price occurred across all markets, while the decrease in closings occurred across the majority of markets. Income before income taxes increased 9% primarily due to higher revenues and gross margins across the majority of markets. Net new orders decreased across all markets. For the nine months ended September 30, 2022, Midwest home sale revenues increased 18% when compared with the prior year period due to a 6% increase in closings combined with an 11% increase in average selling price. The increase in closings occurred across the majority of markets while the increase in average selling price occurred across all markets. Income before income taxes increased 17% primarily due to higher revenues and gross margins across the majority of markets. Net new orders decreased across the majority of markets. Texas For the third quarter of 2022, Texas home sale revenues increased 42% when compared with the prior year period due to a 27% increase in average selling price combined with a 12% increase in closings. The increase in average selling price occurred across all markets while the increase in closings occurred across the majority of markets. Income before income taxes increased 88% primarily due to higher revenues and gross margins across the majority of markets. Net new orders decreased across the majority of markets. For the nine months ended September 30, 2022, Texas home sale revenues increased 27% when compared with the prior year period due to a 24% increase in average selling price combined with a 3% increase in closings. The increase in average selling price occurred across all markets while the increase in closings was mixed among markets. Income before income taxes increased 59% primarily due to higher revenues and gross margins across the majority of markets. Net new orders decreased across the majority of markets. West For the third quarter of 2022, West home sale revenues decreased 6% when compared with the prior year period due to an 11% decrease in closings partially offset by a 5% increase in average selling price. The decrease in closings occurred across the majority of markets, while the increase in average selling price occurred across all markets. Income before income taxes decreased 14% primarily due to decreased revenues and gross margins, which was mixed among markets. The prior year period also included gains of $12.9 million related to a land sale transaction in California. Net new orders decreased across all markets. For the nine months ended September 30, 2022, West home sale revenues increased 9% when compared with the prior year period due to a 14% increase in average selling price partially offset by a 4% decrease in closings. The increase in average selling price occurred across all markets while the decrease in closings occurred across the majority of markets. Income before income taxes increased 16% primarily due to increased revenues and gross margins across the majority of markets. The prior year period also included gains of $12.9 million related to a land sale transaction in California. Net new orders decreased across all markets. 32 Financial Services Operations We conduct our Financial Services operations, which include mortgage banking, title, and insurance brokerage operations, through Pulte Mortgage LLC ("Pulte Mortgage") and other subsidiaries. In originating mortgage loans, we initially use our own funds, including funds available pursuant to a credit agreement 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 loans and related servicing rights for only a short period of time. Operating as a captive business model primarily targeted to support our Homebuilding operations, the business levels of our Financial Services operations are highly correlated to Homebuilding, as Homebuilding customers continue to account for substantially all of its business. We believe that our mortgage 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 tables present selected financial information for our Financial Services operations ($000's omitted): Three Months Ended Nine Months Ended September 30, September 30, 2022 2022 vs. 2021 2021 2022 2022 vs. 2021 2021 Mortgage revenues $ 47,773 (33) % $ 71,238 $ 169,009 (27) % $ 230,505 Title services revenues 19,893 18 % 16,818 55,617 15 % 48,565 Insurance brokerage commissions 5,043 47 % 3,426 15,001 57 % 9,562 Total Financial Services revenues 72,709 (21) % 91,482 239,627 (17) % 288,632 Expenses (45,323) 6 % (42,835) (132,655) 8 % (122,921) Other income (expense), net 128 (a) (8) 1,209 (a) 731 Income before income taxes $ 27,514 (43) % $ 48,639 $ 108,181 (35) % $ 166,442 Total originations: Loans 4,369 (14) % 5,078 12,994 (14) % 15,082 Principal $ 1,715,344 (5) % $ 1,810,722 $ 5,009,957 (3) % $ 5,186,913 (a) Percentage not meaningful. Nine Months Ended September 30, 2022 2021 Supplemental data: Capture rate 78.7 % 86.1 % Average FICO score 748 751 Funded origination breakdown: Government (FHA, VA, USDA) 19 % 20 % Other agency 74 % 73 % Total agency 93 % 93 % Non-agency 7 % 7 % Total funded originations 100 % 100 % Revenues The demand for refinancing within the mortgage industry waned in 2021 and into 2022 as mortgage interest rates began to rise, which led to an increase in competition among lenders and lower margins per loan. As a result, total Financial Services revenues for the three and nine months ended September 30, 2022 decreased 21% and 17%, respectively, compared with the 33 same periods in 2021. The decreases occurred as the result of a decrease in the number of loans originated due to the lower capture rate combined with lower revenue per loan resulting from the competitive lending environment. These factors were partially offset by a higher average loan amount as the result of the higher average selling price within Homebuilding. Income before income taxes Income before income taxes in the three and nine months ended September 30, 2022 decreased 43% and 35% compared to the same periods in 2021, respectively, primarily due to a lower capture rate and revenue per loan due to increased competitiveness in the mortgage industry in 2022. Income Taxes Our effective income tax rate for the three and nine months ended September 30, 2022 was 22.6% and 23.8%, respectively, compared to 23.3% and 22.4%, respectively, for the same periods in 2021. The 2022 effective income tax rate for the three months ended September 30, 2022 was lower than the same period in 2021 due to the retroactive extension of the federal energy efficient home credits in the current year period. The 2022 effective income tax rate for the nine months ended September 30, 2022 was higher than the same period in 2021 due to a reduction in valuation allowances relating to projected utilization of certain state net operating loss carryforwards in 2021. 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 available financing sources, including revolving bank credit and securities offerings. At September 30, 2022, we had unrestricted cash and equivalents of $231.3 million, restricted cash balances of $60.1 million, and $590.3 million available under our Revolving Credit Facility. 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. Our ratio of debt-to-total capitalization, excluding our Financial Services debt, was 22.5% at September 30, 2022, as compared with 21.3% at December 31, 2021. For the next twelve months, we expect our principal demand for funds will be for the acquisition and development of land inventory, construction of house inventory, and operating expenses, including our general and administrative expenses. The elongation of our production cycle has required a greater investment of cash in our homes under production. Additionally, we plan to continue our dividend payments and repurchases of common stock. Within the next twelve months, we need to repay or refinance Pulte Mortgage's master repurchase agreement with third-party lenders (the "Repurchase Agreement"). While we intend to refinance the Repurchase Agreement prior to its maturity, there can be no assurances that the Repurchase Agreement can be renewed or replaced on commercially reasonable terms upon its expiration. However, we believe we have adequate liquidity to meet Pulte Mortgage's anticipated financing needs. Beyond the next twelve months, we will need to repay or refinance our Revolving Credit Facility, which matures in June 2027, and our unsecured senior notes, the next tranche of which becomes due in 2026. We believe that our current cash position and other available financing resources, coupled with our ongoing operating activities, will provide sufficient liquidity to fund our business needs over the next twelve months and beyond. To the extent the sources of capital described above are insufficient to meet our needs, we may also conduct additional public offerings of our securities, refinance debt, dispose of certain assets to fund our operating activities, or draw on existing or new debt facilities. Unsecured senior notes We had $2.0 billion of unsecured senior notes outstanding at both September 30, 2022 and December 31, 2021 with no repayments due until March 2026, when $500.0 million of unsecured senior notes are scheduled to mature. In the nine months ended September 30, 2021, we retired $426.0 million of senior notes at their scheduled maturity date and also accelerated the retirement of $200.0 million and $100.0 million of our unsecured notes scheduled to mature in 2026 and 2027, respectively, through a cash tender offer. The retirement resulted in a loss of $61.5 million, which includes the write-off of debt issuance costs, unamortized discounts and premiums, and transaction fees. 34 Other notes payable Other notes payable include non-recourse and limited recourse secured notes with third parties that totaled $55.2 million and $40.2 million at September 30, 2022 and December 31, 2021, respectively. These notes have maturities ranging up to five years, are secured by the applicable land positions to which they relate, and generally have no recourse to other assets. The stated interest rates on these notes range up to 6%. Revolving credit facility In June 2022, we entered into the Third Amended and Restated Credit Agreement (the "Revolving Credit Facility"), which replaced our previous credit agreement. The Revolving Credit Facility contains substantially similar terms to the previous credit agreement, increased our borrowing capacity, and extended the maturity date from June 2023 to June 2027. The Revolving Credit Facility has a maximum borrowing capacity of $1.3 billion and contains an uncommitted accordion feature that could increase the capacity to $1.8 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, up to the maximum borrowing capacity. The interest rate on borrowings under the Revolving Credit Facility may be based on either the Secured Overnight Financing Rate or a base rate plus an applicable margin, as defined therein. The Revolving Credit Facility contains financial covenants that require us to maintain a minimum Tangible Net Worth and a maximum Debt-to-Capitalization Ratio (as each term is defined in the Revolving Credit Facility). As of September 30, 2022, we were in compliance with all covenants. At September 30, 2022, we had $319.0 million borrowings outstanding, $340.7 million of letters of credit issued, and $590.3 million of remaining capacity under the Revolving Credit Facility. At December 31, 2021, we had no borrowings outstanding, $298.8 million of letters of credit issued, and $701.2 million of remaining capacity under the Revolving Credit Facility. Joint venture debt At September 30, 2022, aggregate outstanding debt of unconsolidated joint ventures was $70.7 million of which $42.0 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 in which our maximum financial loss exposure is limited to our pro rata share of the debt outstanding. Financial Services debt Pulte Mortgage maintains the Repurchase Agreement, which matures on July 27, 2023. The maximum aggregate commitment was $655.0 million at September 30, 2022, which will increase to $800.0 million during the seasonally high borrowing period from December 27, 2022 to January 12, 2023. Thereafter, the maximum aggregate commitment ranges from $360.0 million to $500.0 million. 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 $338.2 million and $626.1 million outstanding under the Repurchase Agreement at September 30, 2022 and December 31, 2021, respectively, and was in compliance with all of its covenants and requirements as of such dates. Dividends and share repurchase program In the nine months ended September 30, 2022, we declared cash dividends totaling $106.7 million and repurchased 21.8 million shares under our repurchase authorization for $974.7 million. In the nine months ended September 30, 2021, we declared cash dividends totaling $110.3 million and repurchased 12.0 million shares under our repurchase authorization for $614.3 million. On January 31, 2022, the Board of Directors approved an additional share repurchase authorization of $1.0 billion. At September 30, 2022, we had remaining authorization to repurchase $482.9 million of common shares. 35 Contractual Obligations We are a party to many contractual obligations involving commitments to make payments to third parties. These obligations impact our short-term and long-term liquidity and capital resource needs. Certain contractual obligations are reflected on the Consolidated Balance Sheet as of September 30, 2022, while others are considered future commitments. Our contractual obligations primarily consist of long-term debt and related interest payments, purchase obligations related to expected acquisitions and development of land, operating leases, and obligations under our various compensation and benefit plans. 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 September 30, 2022, we had outstanding letters of credit totaling $340.7 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 $2.2 billion at September 30, 2022, are typically outstanding over a period of approximately three to five years. 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. 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 September 30, 2022, these agreements had an aggregate remaining purchase price of $6.0 billion. 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. At September 30, 2022, outstanding deposits totaled $273.1 million, of which $17.2 million is refundable. For further information regarding our primary obligations, refer to Note 4 and Note 8 to the Consolidated Financial Statements included elsewhere in this Quarterly Report on 10-Q for amounts outstanding as of September 30, 2022 related to debt and commitments and contingencies, respectively. Cash flows Operating activities Net cash used in operating activities in the nine months ended September 30, 2022 was $303.9 million. Generally, the primary drivers of our cash flow from operations are profitability and changes in the levels of inventory and residential mortgage loans available-for-sale, each of which experiences seasonal fluctuations. The cash outflows from operations for the nine months ended September 30, 2022 were primarily due to net income of $1.7 billion along with a seasonal $507.9 million decrease in residential mortgage loans available for sale, offset by a net increase in inventories of $2.7 billion, which was primarily attributable to higher house inventory in production resulting from a large order backlog, more unsold units, and extended production cycle times combined with investment in land inventory. Net cash provided by operating activities in the nine months ended September 30, 2021 was $548.2 million. The positive cash flow from operations in nine months ended September 30, 2021 was primarily due to our net income of $1.3 billion, which included various non-cash items including a loss on debt retirement of $61.5 million, partially offset by a net increase in inventories of $1.1 billion, which was primarily attributable to higher house inventory in production resulting from higher sales activity and extended production cycle times combined with higher investment in land inventory to support future growth. Investing activities Net cash used in investing activities in the nine months ended September 30, 2022 was $154.7 million. These cash outflows primarily reflected a $10.4 million deferred payment related to the 2020 acquisition of Innovative Construction Group ("ICG"), $58.2 million of investments in unconsolidated entities, and capital expenditures of $88.6 million related to our ongoing investments in new communities, facilities, and information technology applications. Net cash used in investing activities in the nine months ended September 30, 2021 was $86.5 million. These cash outflows in 2021 primarily reflected a $10.4 million deferred payment related to ICG, $35.8 million of investments in unconsolidated entities, and capital expenditures of $52.1 million related to our ongoing investments in new communities and information technology applications. These outflows were partially offset by distributions from unconsolidated entities of $11.5 million. 36 Financing activities Net cash used in financing activities in the nine months ended September 30, 2022 totaled $1.1 billion. These cash outflows resulted primarily from the repurchase of 21.8 million common shares for $974.7 million under our share repurchase authorization, payments of $109.6 million in cash dividends, and net repayments of $287.9 million under the Repurchase Agreement related to a seasonal reduction in residential mortgage loans available-for-sale. These cash outflows were partially offset by net borrowings of $319.0 million under the Revolving Credit Facility. Net cash used in financing activities in the nine months ended September 30, 2021 totaled $1.5 billion. These cash outflowsresulted primarily from the repurchase of 12.0 million common shares for $614.3 million under our share repurchase authorization, repayments of debt totaling $797.4 million, and payments of $111.7 million in cash dividends. These cash outflows were partially offset by net borrowings of $64.7 million under the Repurchase Agreement. 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 in 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. Additionally, given the disruption in economic activity caused by the COVID-19 pandemic, supply chain challenges, increase in mortgage interest rates, and other macroeconomic factors, our quarterly results for 2022 and 2021 are not necessarily indicative of results that may be achieved in the future. Supplemental Guarantor Financial Information As of September 30, 2022, PulteGroup, Inc. had outstanding $2.0 billion principal amount of unsecured senior notes due at dates from March 2026 through February 2035 and $319.0 million amounts outstanding on its Revolving Credit Facility. All of our unsecured senior notes and the Revolving Credit Facility are fully and unconditionally guaranteed, on a joint and several basis, by certain subsidiaries of PulteGroup, Inc. ("Guarantors" or "Guarantor Subsidiaries"). Each of the Guarantor Subsidiaries is 100% owned, directly or indirectly, by PulteGroup, Inc. Our subsidiaries associated with our financial services operations and certain other subsidiaries do not guarantee the unsecured senior notes or the Revolving Credit Facility (collectively, "Non-Guarantor Subsidiaries"). The guarantees are senior unsecured obligations of each Guarantor and rank equal with all existing and future senior debt of such Guarantor and senior to all subordinated debt of such Guarantor. The guarantees are effectively subordinated to any secured debt of such Guarantor to the extent of the value of the assets securing such debt. A court could void or subordinate any Guarantor’s guarantee under the fraudulent conveyance laws if existing or future creditors of any such Guarantor were successful in establishing that such Guarantor: (a) incurred the guarantee with the intent of hindering, delaying or defrauding creditors; or (b) received less than reasonably equivalent value or fair consideration in return for incurring the guarantee and, in the case of any one of the following is also true at the time thereof: • such Guarantor was insolvent or rendered insolvent by reason of the issuance of the incurrence of the guarantee; • the incurrence of the guarantee left such Guarantor with an unreasonably small amount of capital or assets to carry on its business; • such Guarantor intended to, or believed that it would, incur debts beyond its ability to pay as they mature; or • such Guarantor was a defendant in an action for money damages, or had a judgment for money damages docketed against it, if the judgment is unsatisfied after final judgment. The measures of insolvency for purposes of determining whether a fraudulent conveyance occurred would vary depending upon the laws of the relevant jurisdiction and upon the valuation assumptions and methodology applied by the court. However, in general, a court would deem a company insolvent if: 37 • the sum of its debts, including contingent and unliquidated liabilities, was greater than the fair salable value of all of its assets; • the present fair salable value of its assets was less than the amount that would be required to pay its probable liability on its existing debts, including contingent liabilities, as they become absolute and mature; or • it could not pay its debts as they became due. The guarantees of the senior notes contain a provision to limit each Guarantor’s liability to the maximum amount that it could incur without causing the incurrence of obligations under its guarantee to be a fraudulent transfer. However, under recent case law, this provision may not be effective to protect such guarantee from being voided under fraudulent transfer law or otherwise determined to be unenforceable. If a court were to find that the incurrence of a guarantee was a fraudulent transfer or conveyance, the court could void the payment obligations under that guarantee, could subordinate that guarantee to presently existing and future indebtedness of the Guarantor or could require the holders of the senior notes to repay any amounts received with respect to that guarantee. In the event of a finding that a fraudulent transfer or conveyance occurred, you may not receive any repayment on the senior notes. Finally, as a court of equity, a bankruptcy court may subordinate the claims in respect of the guarantees to other claims against us under the principle of equitable subordination if the court determines that (1) the holder of senior notes engaged in some type of inequitable conduct, (2) the inequitable conduct resulted in injury to our other creditors or conferred an unfair advantage upon the holders of senior notes, and (3) equitable subordination is not inconsistent with the provisions of the bankruptcy code. On the basis of historical financial information, operating history and other factors, we believe that each of the Guarantors, after giving effect to the issuance of the guarantees when such guarantees were issued, was not insolvent, did not have unreasonably small capital for the business in which it engaged and did not and has not incurred debts beyond its ability to pay such debts as they mature. There can be no assurance, however, as to what standard a court would apply in making these determinations or that a court would agree with our conclusions in this regard. The following tables present summarized financial information for PulteGroup, Inc. and the Guarantor Subsidiaries on a combined basis after intercompany transactions and balances have been eliminated among PulteGroup, Inc. and the Guarantor Subsidiaries, as well as their investment in and equity in earnings from the Non-Guarantor Subsidiaries ($000’s omitted): PulteGroup, Inc. and Guarantor Subsidiaries Summarized Balance Sheet Data ASSETS September 30, 2022 December 31, 2021 Cash, cash equivalents, and restricted cash $134,930 $1,598,328 House and land inventory 11,475,615 8,859,163 Amount due from Non-Guarantor Subsidiaries 56,535 278,531 Total assets 12,889,975 11,658,352 LIABILITIES Accounts payable, customer deposits, accrued and other liabilities $2,846,809 $2,788,465 Notes payable 2,045,167 2,029,044 Total liabilities 5,393,580 4,986,491 Nine Months Ended September 30, Summarized Statement of Operations Data 2022 2021 Revenues $10,600,314 $9,035,505 Cost of revenues 7,412,687 6,664,370 Selling, general, and administrative expenses 971,786 852,397 Income before income taxes 2,143,273 1,427,182 38 Critical Accounting Estimates While there have been no significant changes to our critical accounting estimates in the nine months ended September 30, 2022 compared with those contained in Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the year ended December 31, 2021, the following provides updated disclosure regarding our inventory estimates: Generally, a community must have projected gross margin percentages in the single digits in order to potentially fail the undiscounted cash flow step and proceed to the fair value step. Our overall gross margin realized in the three months ended September 30, 2022 exceeded 30%, and we have only a small minority of communities with gross margins below 10%. However, in the event of an extended economic slowdown or other factors that lead to moderate or significant decreases in the price of new homes in certain geographic or buyer submarkets, we could have a larger number of communities that begin to approach these levels such that more detailed impairment analyses would be necessary, and the resulting impairments could be material. Additionally, we have $449.5 million of deposits and pre-acquisition costs at September 30, 2022 related to option agreements to acquire additional land. In the event of an extended economic slowdown or moderate to significant decreases in new home prices, we could elect to cancel a large portion of such land option agreements, which would generally result in the write-off of the related deposits and pre-acquisition costs.