Income Taxes

The Company records income taxes under the asset and liability method, whereby deferred tax assets and liabilities are recognized based on future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and attributable to operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply in the years in which the temporary differences are expected to be recovered or paid. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in earnings in the period when the changes are enacted. At September 30, 2013, the Company's net gross deferred tax asset balance was $126.6 million, of which $127.6 million were gross deferred tax assets (reported as such on the Company's consolidated balance sheets, net of a $14.9 million valuation allowance), and $1.0 million were gross deferred tax liabilities (included in other liabilities on the Company's consolidated balance sheets).

In accordance with ASC 740-10, Income Taxes, we evaluate our deferred tax assets, including the benefit from net operating losses (“NOLs”) and tax credit carryforwards, to determine if a valuation allowance is required. Companies must assess, using significant judgments, whether a valuation allowance should be established based on the consideration of all available evidence using a “more likely than not” standard with significant weight being given to evidence that can be objectively verified. This assessment gives appropriate consideration to all positive and negative evidence related to the realization of the deferred tax assets and considers, among other matters, the nature, frequency and severity of current and cumulative losses, forecasts of future profitability, the length of statutory carryforward periods, our experience with operating losses and our experience of utilizing tax credit carryforwards and tax planning alternatives. Based upon a review of all available evidence, we recorded a full valuation allowance against our deferred tax assets during 2008 due to economic conditions and the weight of negative evidence at the time.

During the quarter ended September 30, 2013, the Company concluded that it was more likely than not that the majority of its deferred tax assets would be utilized. This conclusion was based on a detailed evaluation of all relevant evidence, both positive and negative. The Company is required to use judgment in considering the relative impact of negative and positive evidence when determining the need for a valuation allowance for its deferred tax asset. The weight given to the potential effect of negative and positive evidence shall be commensurate with the extent to which it can be objectively verified. The more negative evidence that exists, the more positive evidence is needed.

The positive evidence considered by the Company in its evaluation for each of our taxing jurisdictions was the objective evidence related to our past and current financial results, including a period of sustained profitability comprising six consecutive quarters of pre-tax net income totaling $43.2 million, and the projected utilization of a majority of our current NOL carryforwards and temporary differences as they reverse in the carryforward periods, generally 20 years. Other positive evidence considered, among other things, was our expectation of continued earnings, and continued indications of a sustained recovery in the housing markets in which the Company operates, as evidenced by the significant increases experienced by the Company in several key financial indicators compared to the prior year, including new contracts, revenues, backlog sales value, new home deliveries and declining overhead leverage as a percent of revenue. We believe that economic data, such as recent and forecasted increases in housing starts, homebuilding volume and average sales prices, also affirm the recovery in the housing industry. We believe historically low mortgage rates, affordable home prices, reduced foreclosures, and a favorable home ownership to rental comparison continue to drive the recovery in the housing industry.

The most significant direct negative evidence that currently exists is that the Company is currently in a four-year cumulative loss position, which period represents our estimated business cycle. However, at September 30, 2013, the Company's cumulative four-year loss has declined significantly as a result of six consecutive quarters of profitability and, based on the Company's current earnings level, the Company will realize a majority of its deferred tax assets. Other negative evidence considered was the recent rise in mortgage interest rates and the potential impact of such rise on our business. While we believe it has caused a temporary slow down in the pace of the housing recovery and related trends compared to previous quarters in 2013, we believe the demand for housing continues to increase new contracts, as evidenced by the 15% increase in new contracts that we experienced during the three months ended September 30, 2013 when compared to the same period in 2012 as well as other factors.

Based on its analysis of positive and negative evidence, the Company concluded that the objective positive evidence outweighed the negative evidence, and that the Company will more likely than not realize a majority of its deferred tax assets. In accordance with GAAP, when a change in valuation allowance is recognized as a result of a change in judgment in an interim period, a portion of the valuation allowance to be reversed must be spread over the remaining interim periods. Accordingly, the Company reversed $111.6 million of its deferred tax asset valuation allowance during the third quarter of 2013 and retained a $4.7 million valuation allowance for estimated utilization pertaining to estimated earnings in the fourth quarter of 2013. In addition to the retained $4.7 million valuation allowance, the Company retained an additional $10.2 million valuation allowance for certain state jurisdictions which have a shorter NOL carryforward utilization period or a large NOL carryforward relative to their current earnings. In future periods, the remaining valuation allowance for these state jurisdictions will be evaluated to determine if sufficient positive evidence indicates that it is more likely than not that an additional portion of the underlying state NOL carryforwards will be realized. The Company's net gross deferred tax assets were $126.6 million at September 30, 2013, which, inclusive of our valuation allowance, results in a net deferred tax asset of $111.6 million.

The tax effects of the significant temporary differences that comprise the deferred tax assets and liabilities are as follows:



(In thousands)	September 30, 2013			December 31, 2012
Deferred tax assets:
Warranty, insurance and other accruals	$	11,487		11,378
Inventory	17,417			22,612
State taxes	71			(64	)
Net operating loss carryforward	98,007			102,475
Deferred charges	613			336
Total deferred tax assets	127,595			136,737

Deferred tax liabilities:
Depreciation	397			804
Prepaid expenses	639			184
Total deferred tax liabilities	1,036			988

Net total deferred tax assets	126,559			135,749
Less valuation allowance	(14,913		)	(135,749	)
Total deferred tax assets, net of valuation allowance	111,646			—

The benefit from income taxes consists of the following:



	Three Months Ended September 30,					Nine Months Ended September 30,
(In thousands)	2013			2012		2013			2012
Current:
Federal	$	2		$	—	$	2		$	—
State	$	85		$	138	$	515		$	(955	)
	$	87		$	138	$	517		$	(955	)

(In thousands)
Deferred:
Federal	$	(104,751	)	$	—	$	(104,751	)	$	—
State	$	(6,895	)	$	—	$	(6,895	)	$	—
	(111,646		)	—		(111,646		)	—
Total	$	(111,559	)	$	138	$	(111,129	)	$	(955	)

At September 30, 2013, the Company had federal NOL carryforwards of approximately $77.8 million and federal credit carryforwards of $4.3 million. Federal NOL carryforwards may be carried forward up to 20 years to offset future taxable income. Our federal carryforward benefits begin to expire in 2028. The Company had $15.9 million of state NOL carryforwards at September 30, 2013. State NOLs may be carried forward from 5 to 20 years, depending on the tax jurisdiction, with $8.9 million expiring between 2013 and 2027 and $7.0 million expiring between 2028 and 2032, absent sufficient state taxable income. As of September 30, 2013, we have recorded a $10.2 million valuation allowance against these state NOLs.