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

Results of Operations — Fiscal Year 2018 Overview

During fiscal 2018, demand for new homes across most of our markets was strong, particularly at affordable price points, and the supply of new homes for sale remained limited. The level of strength in new home demand and home prices varied across our markets based on the relative strength of each market’s economy, as measured by job growth, household incomes, household formations and consumer confidence and the relative affordability of new home prices as compared to household incomes in each market.

Sales prices for both new and resale homes have increased across most of our markets over the past several years, which has generally reduced housing affordability. During fiscal 2018, interest rates on mortgage loans increased, which further impacted affordability. These conditions have resulted in some recent moderation of demand for new homes, particularly at higher price points. However, we continue to see solid economic fundamentals and a limited supply of homes at affordable prices across most of our markets.

Our position as the most geographically diverse and largest volume homebuilder in the United States provides a strong platform for us to compete for new home sales. In recent years, we have expanded our product offerings to include a broad range of homes for entry-level, move-up and luxury buyers across most of our markets. Our affordable entry-level homes have experienced very strong demand from homebuyers, as the entry-level segment of the new home market remains under-served, with low inventory levels relative to demand. More recently, we have also been introducing homes at affordable price points in communities designed for active adult buyers seeking a low-maintenance lifestyle.

We believe our business is well positioned with a broad geographic footprint, diverse product offerings, a balanced supply of finished lots, land and homes, a strong balance sheet and liquidity and experienced personnel across our operating markets. We remain focused on growing our revenues and profitability, generating positive annual cash flows from operations and managing our product offerings, pricing, sales pace, and inventory levels to optimize the return on our inventory investments.

In fiscal 2018, our number of homes closed and home sales revenues increased 13% and 14%, respectively, compared to the prior year. Our pre-tax income was $2.1 billion in fiscal 2018 compared to $1.6 billion in fiscal 2017 and $1.4 billion in fiscal 2016. Our pre-tax operating margin increased to 12.8% in fiscal 2018 compared to 11.4% in fiscal 2017 and 11.1% in fiscal 2016. The increase in 2018 compared to 2017 was primarily the result of an increase in our home sales gross margin. During fiscal 2018, we reduced sales incentives or raised prices in communities where we were achieving our targeted sales pace, while striving to ensure our product offerings remained affordable. As land and construction costs have generally increased, we have leveraged our scale and relationships to control these increases. Cash provided by our homebuilding operations was $1.0 billion in fiscal 2018 compared to $303.7 million in fiscal 2017 and $580.5 million in fiscal 2016. In fiscal 2018, our homebuilding return on inventory (ROI) improved to 20.2% compared to 16.6% in fiscal 2017 and 15.4% in fiscal 2016. Homebuilding ROI is calculated as homebuilding pre-tax income for the year divided by average inventory. Average inventory in the ROI calculation is the sum of ending inventory balances for the trailing five quarters divided by five.

Within our homebuilding land and lot portfolio, our lots controlled under option purchase contracts represent 57% of the lots owned and controlled at September 30, 2018 compared to 50% at September 30, 2017. The Forestar acquisition is advancing our homebuilding strategy of increasing our access to optioned land and lot positions.

We believe that housing demand in our individual operating markets is tied closely to each market’s economy. Therefore, we expect that housing market conditions will continue to vary across our markets. If the U.S. economy remains strong, we expect to see continued strength in housing demand, concentrated in markets where job growth is occurring and new home prices remain affordable relative to household incomes. The pace and sustainability of new home demand and our future results could be negatively affected by weakening economic conditions, decreases in the level of employment and housing demand, decreased home affordability, further increases in mortgage interest rates or tightening of mortgage lending standards.

Strategy

Our operating strategy focuses on leveraging our financial and competitive position to increase the returns on our inventory investments and generate strong profitability and cash flows, while managing risk and maintaining financial flexibility to make opportunistic strategic investments. This strategy includes the following initiatives:

•	Maintaining a strong cash balance and overall liquidity position and controlling our level of debt.

•	Allocating and actively managing our inventory investments across our operating markets to diversify our geographic risk.

•	Offering new home communities that appeal to a broad range of entry-level, move-up, active adult and luxury homebuyers based on consumer demand in each market.

•	Modifying product offerings, sales pace, home prices and sales incentives as necessary in each of our markets to meet consumer demand and maintain affordability.

•	Delivering high quality homes to our customers and a positive experience both during and after the sale.

•	Managing our inventory of homes under construction relative to demand in each of our markets, including starting construction on unsold homes to capture new home demand and actively controlling the number of unsold, completed homes in inventory.

•	Investing in land and land development in desirable markets, while controlling the level of land and lots we own in each of our markets relative to the local new home demand.

•	Increasing the amount of land and finished lots controlled through option purchase contracts by expanding relationships with land developers across the country and growing our majority-owned Forestar lot development operations.

•	Pursuing acquisitions of companies to enhance and improve the returns of our homebuilding and other operations.

•	Controlling the cost of goods purchased from both vendors and subcontractors.

•	Improving the efficiency of our land development, construction, sales and other key operational activities.

•	Controlling our selling, general and administrative (SG&A) expense infrastructure to match production levels.

We believe our operating strategy, which has produced positive results in recent years, will allow us to maintain and improve our financial and competitive position and balance sheet strength. However, we cannot provide any assurances that the initiatives listed above will continue to be successful, and we may need to adjust components of our strategy to meet future market conditions.

Key Results

Key financial results as of and for our fiscal year ended September 30, 2018 (or from the acquisition date of October 5, 2017 through September 30, 2018 for Forestar’s results), as compared to fiscal 2017, were as follows:

Homebuilding:

•	Homebuilding revenues increased 14% to $15.6 billion.

•	Homes closed increased 13% to 51,857 homes, and the average closing price of those homes was $298,900.

•	Net sales orders increased 13% to 52,740 homes, and the value of net sales orders increased 13% to $15.8 billion.

•	Sales order backlog increased 8% to 13,371 homes, and the value of sales order backlog increased 8% to $4.0 billion.

•	Home sales gross margin increased 130 basis points to 21.3%.

•	Homebuilding SG&A expenses as a percentage of homebuilding revenues decreased by 30 basis points to 8.6%.

•	Homebuilding pre-tax income increased 31% to $2.0 billion compared to $1.5 billion.

•	Homebuilding pre-tax income as a percentage of homebuilding revenues improved to 12.5% compared to 10.8%.

•	Homebuilding return on inventory improved 360 basis points to 20.2%.

•	Net cash provided by homebuilding operations increased to $1.0 billion compared to $303.7 million.

•	Homebuilding cash and cash equivalents totaled $1.1 billion compared to $973.0 million.

•	Homebuilding inventories totaled $9.9 billion compared to $9.2 billion.

•	Homes in inventory totaled 29,700 compared to 26,200.

•	Owned lots totaled 124,300 compared to 125,000, and lots controlled through option purchase contracts totaled 164,200 compared to 124,000.

•	Homebuilding debt was $2.4 billion compared to $2.5 billion.

•	Homebuilding debt to total capital improved to 21.4% from 24.0%.

Forestar:

•	Forestar’s revenues were $109.2 million, which included $39.1 million of revenues from land and lot sales to our homebuilding segment.

•	Forestar’s pre-tax income was $48.7 million, which included gross profit of $9.0 million from land and lot sales to our homebuilding segment.

•	Owned and controlled lots totaled 20,100. Of these lots, 13,600 were under contract to sell to or subject to a right of first offer with D.R. Horton.

•	Forestar’s cash and cash equivalents totaled $318.8 million.

•	Forestar’s inventories totaled $498.0 million.

Financial Services:

•	Financial services revenues increased 7% to $375.3 million.

•	Financial services pre-tax income was $117.8 million compared to $124.5 million.

•	Financial services pre-tax income as a percentage of financial services revenues was 31.4% compared to 35.6%.

Consolidated Results:

•	Consolidated pre-tax income increased 29% to $2.1 billion compared to $1.6 billion.

•	Consolidated pre-tax income as a percentage of consolidated revenues was 12.8% compared to 11.4%.

•	Income tax expense was $597.7 million, which included a charge of $108.7 million as a result of the Tax Cuts and Jobs Act, compared to $563.7 million.

•	Net income attributable to D.R. Horton increased 41% to $1.5 billion compared to $1.0 billion.

•	Diluted earnings per common share attributable to D.R. Horton increased 39% to $3.81 compared to $2.74.

•	Net cash provided by operations was $545.2 million compared to $440.2 million.

•	Stockholders’ equity was $9.0 billion compared to $7.7 billion.

•	Book value per common share increased 16% to $23.88 compared to $20.66.

•	Debt to total capital improved to 26.3% from 27.0%.

Results of Operations — Homebuilding

Our operating segments are our 46 homebuilding divisions, our majority-owned Forestar lot development operations, our financial services operations and our other business activities. The homebuilding operating segments are aggregated into six reporting segments. These reporting segments, which we also refer to as reporting regions, have homebuilding operations located in the following states:

	East:		Delaware, Georgia (Savannah only), Maryland, New Jersey, North Carolina, Pennsylvania, South Carolina and Virginia
	Midwest:		Colorado, Illinois, Indiana and Minnesota
	Southeast:		Alabama, Florida, Georgia, Mississippi and Tennessee
	South Central:		Louisiana, Oklahoma and Texas
	Southwest:		Arizona and New Mexico
	West:		California, Hawaii, Nevada, Oregon, Utah and Washington

The following tables and related discussion set forth key operating and financial data for our homebuilding operations by reporting segment as of and for the fiscal years ended September 30, 2018, 2017 and 2016.

Net Sales Orders (1)		Net Homes Sold
	Fiscal Year Ended September 30,												% Change
		2018				2017				2016				2018 vs 2017			2017 vs 2016
East		6,994				6,039				4,944				16	%		22	%
Midwest		2,209				1,841				1,766				20	%		4	%
Southeast		17,380				15,575				13,616				12	%		14	%
South Central		15,317				13,374				12,433				15	%		8	%
Southwest		3,179				2,693				1,761				18	%		53	%
West		7,661				7,083				6,294				8	%		13	%
		52,740				46,605				40,814				13	%		14	%
		Value (In millions)
East		$	1,988.8			$	1,708.9			$	1,388.5			16	%		23	%
Midwest		864.3				722.6				669.2				20	%		8	%
Southeast		4,640.7				4,068.9				3,547.3				14	%		15	%
South Central		3,849.8				3,339.1				3,045.4				15	%		10	%
Southwest		784.4				620.5				409.0				26	%		52	%
West		3,632.7				3,481.2				2,940.8				4	%		18	%
		$	15,760.7			$	13,941.2			$	12,000.2			13	%		16	%
		Average Selling Price
East		$	284,400			$	283,000			$	280,800			—	%		1	%
Midwest		391,300				392,500				378,900				—	%		4	%
Southeast		267,000				261,200				260,500				2	%		—	%
South Central		251,300				249,700				244,900				1	%		2	%
Southwest		246,700				230,400				232,300				7	%		(1	)%
West		474,200				491,500				467,200				(4	)%		5	%
		$	298,800			$	299,100			$	294,000			—	%		2	%

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(1)	Net sales orders represent the number and dollar value of new sales contracts executed with customers (gross sales orders), net of cancelled sales orders.

		Sales Order Cancellations
		Fiscal Year Ended September 30,
		Cancelled Sales Orders						Value (In millions)												Cancellation Rate (1)
		2018		2017		2016		2018				2017				2016				2018			2017			2016
East		2,031		1,818		1,582		$	570.0			$	500.3			$	425.4			23	%		23	%		24	%
Midwest		299		260		241		115.1				103.6				91.6				12	%		12	%		12	%
Southeast		5,655		4,898		4,413		1,502.5				1,252.5				1,105.9				25	%		24	%		24	%
South Central		4,408		3,989		3,795		1,091.9				1,000.8				942.5				22	%		23	%		23	%
Southwest		1,031		864		745		251.8				196.9				160.4				24	%		24	%		30	%
West		1,378		1,221		1,119		661.3				616.9				544.7				15	%		15	%		15	%
		14,802		13,050		11,895		$	4,192.6			$	3,671.0			$	3,270.5			22	%		22	%		23	%

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(1)	Cancellation rate represents the number of cancelled sales orders divided by gross sales orders.

Net Sales Orders

2018 versus 2017

The value of net sales orders increased 13% to $15.8 billion (52,740 homes) in 2018 from $13.9 billion (46,605 homes) in 2017, with increases in all of our regions. The increases in the value of sales orders were due to increased volume. The average selling price of homes sold during fiscal 2018 was $298,800, essentially unchanged from the prior year.

The number of net sales orders increased 13% during 2018 compared to 2017. The increase in net sales orders reflects the strength in demand in most of our markets, particularly at affordable price points. Our Chicago and Phoenix markets contributed the most to higher sales volumes in our Midwest and Southwest regions, respectively. Our sales order cancellation rate (cancelled sales orders divided by gross sales orders for the period) was 22% in both years.

We believe our business is well positioned to continue to generate increased sales volume; however, our future sales volumes will depend on new home demand in each of our operating markets and our ability to successfully implement our operating strategies.

2017 versus 2016

The value of net sales orders increased 16% to $13.9 billion (46,605 homes) in 2017 from $12.0 billion (40,814 homes) in 2016, with increases in all of our regions. The increase in the value of sales orders was due to increased volume and to a lesser extent, increased selling prices in some regions.

The number of net sales orders increased 14%, and the average price of net sales orders increased 2% to $299,100 during 2017 compared to 2016. Our Phoenix and Carolina markets contributed the most to higher sales volumes in our Southwest and East regions, respectively. Our sales order cancellation rate was 22% in 2017 compared to 23% in 2016.

Sales Order Backlog		Homes in Backlog
	As of September 30,												% Change
		2018				2017				2016				2018 vs 2017			2017 vs 2016
East		1,841				1,544				1,301				19	%		19	%
Midwest		442				419				470				5	%		(11	)%
Southeast		4,221				4,057				4,053				4	%		—	%
South Central		4,492				3,956				3,840				14	%		3	%
Southwest		928				843				655				10	%		29	%
West		1,447				1,510				1,156				(4	)%		31	%
		13,371				12,329				11,475				8	%		7	%
		Value (In millions)
East		$	548.6			$	452.8			$	383.0			21	%		18	%
Midwest		179.2				172.5				184.0				4	%		(6	)%
Southeast		1,172.3				1,104.9				1,121.7				6	%		(1	)%
South Central		1,151.8				1,018.1				1,018.1				13	%		—	%
Southwest		251.7				192.7				150.7				31	%		28	%
West		725.3				785.0				580.5				(8	)%		35	%
		$	4,028.9			$	3,726.0			$	3,438.0			8	%		8	%
		Average Selling Price
East		$	298,000			$	293,300			$	294,400			2	%		—	%
Midwest		405,400				411,700				391,500				(2	)%		5	%
Southeast		277,700				272,300				276,800				2	%		(2	)%
South Central		256,400				257,400				265,100				—	%		(3	)%
Southwest		271,200				228,600				230,100				19	%		(1	)%
West		501,200				519,900				502,200				(4	)%		4	%
		$	301,300			$	302,200			$	299,600			—	%		1	%

Sales Order Backlog

Sales order backlog represents homes under contract but not yet closed at the end of the period. Many of the contracts in our sales order backlog are subject to contingencies, including mortgage loan approval and buyers selling their existing homes, which can result in cancellations. A portion of the contracts in backlog will not result in closings due to cancellations. Our acquisition of the assets of Permian Homes contributed 159 homes valued at $44.2 million to the sales order backlog of our South Central region during fiscal 2018.

Home Closings and Revenue		Homes Closed
	Fiscal Year Ended September 30,												% Change
		2018				2017				2016				2018 vs 2017			2017 vs 2016
East		6,697				5,796				5,126				16	%		13	%
Midwest		2,186				1,892				1,708				16	%		11	%
Southeast		17,216				15,571				13,303				11	%		17	%
South Central		14,940				13,258				12,249				13	%		8	%
Southwest		3,094				2,505				1,703				24	%		47	%
West		7,724				6,729				6,220				15	%		8	%
		51,857				45,751				40,309				13	%		14	%
		Home Sales Revenue (In millions)
East		$	1,893.0			$	1,639.1			$	1,431.0			15	%		15	%
Midwest		857.5				734.1				651.7				17	%		13	%
Southeast		4,573.3				4,085.7				3,459.3				12	%		18	%
South Central		3,760.4				3,339.1				2,978.5				13	%		12	%
Southwest		725.4				578.5				388.1				25	%		49	%
West		3,692.4				3,276.7				2,874.5				13	%		14	%
		$	15,502.0			$	13,653.2			$	11,783.1			14	%		16	%
		Average Selling Price
East		$	282,700			$	282,800			$	279,200			—	%		1	%
Midwest		392,300				388,000				381,600				1	%		2	%
Southeast		265,600				262,400				260,000				1	%		1	%
South Central		251,700				251,900				243,200				—	%		4	%
Southwest		234,500				230,900				227,900				2	%		1	%
West		478,000				487,000				462,100				(2	)%		5	%
		$	298,900			$	298,400			$	292,300			—	%		2	%

2018 versus 2017

Revenues from home sales increased 14% to $15.5 billion (51,857 homes closed) in 2018 from $13.7 billion (45,751 homes closed) in 2017. The increase in home sales revenues reflects the strength in demand in most of our markets, particularly at affordable price points.

The number of homes closed in fiscal 2018 increased 13% from 2017 due to increases in all of our regions. Our Phoenix, Carolina and Minneapolis markets contributed the most to higher closing volumes in our Southwest, East and Midwest regions, respectively. The average selling price of homes closed during fiscal 2018 was $298,900, essentially unchanged from the prior year.

2017 versus 2016

Revenues from home sales increased 16% to $13.7 billion (45,751 homes closed) in 2017 from $11.8 billion (40,309 homes closed) in 2016.

The number of homes closed in fiscal 2017 increased 14% from 2016 due to increases in all of our regions. Our Phoenix, Florida and Carolina markets contributed the most to higher closing volumes in our Southwest, Southeast and East regions, respectively. The average selling price of homes closed during fiscal 2017 was $298,400, up 2% from the prior year.

Homebuilding Operating Margin Analysis

		Percentages of Related Revenues
		Fiscal Year Ended September 30,
		2018			2017			2016
Gross profit — home sales		21.3	%		20.0	%		20.2	%
Gross profit — land/lot sales and other		18.6	%		15.3	%		13.3	%
Inventory and land option charges		(0.3	)%		(0.3	)%		(0.3	)%
Gross profit — total homebuilding		21.0	%		19.6	%		19.9	%
Selling, general and administrative expense		8.6	%		8.9	%		9.3	%
Goodwill impairment		—	%		—	%		0.1	%
Gain on sale of assets		(0.1	)%		—	%		—	%
Other (income) expense		—	%		(0.1	)%		(0.1	)%
Homebuilding pre-tax income		12.5	%		10.8	%		10.7	%

Home Sales Gross Profit

2018 versus 2017

Gross profit from home sales increased 21% to $3.3 billion in 2018 from $2.7 billion in 2017 and increased 130 basis points to 21.3% as a percentage of home sales revenues. The percentage increase resulted from improvements of 60 basis points due to the average selling price of our homes closed increasing by more than the average cost, 40 basis points from a decrease in warranty and construction defect expenses and 30 basis points from a decrease in the amortization of capitalized interest.

We remain focused on managing the pricing, incentives and sales pace in each of our communities to optimize the returns on our inventory investments and adjust to local market conditions and new home demand. These actions could cause our gross profit margins to fluctuate in future periods.

2017 versus 2016

Gross profit from home sales increased 15% to $2.7 billion in 2017 from $2.4 billion in 2016 and decreased 20 basis points to 20.0% as a percentage of home sales revenues. The percentage decrease resulted from a decrease of 50 basis points due to an increase in warranty and construction defect expenses, partially offset by an improvement of 30 basis points due to a decrease in the amortization of capitalized interest.

Land Sales and Other Revenues

Land sales and other revenues from our homebuilding operations were $121.8 million, $88.3 million and $78.7 million in fiscal 2018, 2017 and 2016, respectively. Land sales and other revenues during fiscal 2018 included $39.5 million from the sale of a parcel of land in Phoenix. We continually evaluate our land and lot supply, and fluctuations in revenues and profitability from land sales occur based on how we manage our inventory levels in various markets. We generally purchase land and lots with the intent to build and sell homes on them. However, some of the land that we purchase includes commercially zoned parcels that we may sell to commercial developers. We may also sell residential lots or land parcels to manage our supply or for other strategic reasons. As of September 30, 2018, our homebuilding operations had $40.2 million of land held for sale that we expect to sell in the next twelve months.

Inventory and Land Option Charges

At the end of each quarter during fiscal 2018, we reviewed the performance and outlook for all of our communities and land inventories for indicators of potential impairment and performed detailed impairment evaluations and analyses when necessary. As of September 30, 2018, we performed detailed impairment evaluations of communities and land inventories with a combined carrying value of $60.5 million and recorded impairment charges of $2.6 million during the fourth quarter to reduce the carrying value of impaired communities and land to fair value. Total homebuildingu impairment charges during fiscal 2018, 2017 and 2016 were $10.9 million, $23.2 million and $20.3 million, respectively.

As we manage our inventory investments across our operating markets to optimize returns and cash flows, we may modify our pricing and incentives, construction and development plans or land sale strategies in individual active communities and land held for development, which could result in the affected communities being evaluated for potential impairment. Also, if housing or economic conditions weaken in specific markets in which we operate, or if conditions weaken in the broader economy or homebuilding industry, we may be required to evaluate additional communities for potential impairment. These evaluations could result in additional impairment charges.

During fiscal 2018, 2017 and 2016, earnest money and pre-acquisition cost write-offs related to land option contracts that we have terminated or expect to terminate were $13.4 million, $17.0 million and $11.1 million, respectively. Total homebuilding inventory and land option charges of $48.8 million for fiscal 2018 also include a charge of $24.5 million in the second quarter related to the settlement of an outstanding dispute associated with a land transaction.

Selling, General and Administrative (SG&A) Expense

SG&A expense from homebuilding activities was $1.3 billion, $1.2 billion and $1.1 billion in fiscal 2018, 2017 and 2016, respectively, an increase of 10% in 2018 and 11% in 2017 from the respective prior years. As a percentage of homebuilding revenues, SG&A expense decreased 30 basis points to 8.6% in 2018 and decreased 40 basis points to 8.9% in 2017 from the respective prior years.

Employee compensation and related costs were $964.2 million, $860.2 million and $748.7 million in fiscal 2018, 2017 and 2016, respectively, representing 72%, 70% and 68% of SG&A costs in those years. These costs increased 12% in 2018 and 15% in 2017 due to increases in the number of employees and the amount of incentive compensation as compared to the respective prior years. Our homebuilding operations employed 6,419, 5,876 and 5,356 employees at September 30, 2018, 2017 and 2016, respectively.

We attempt to control our SG&A costs while ensuring that our infrastructure adequately supports our operations; however, we cannot make assurances that we will be able to maintain or improve upon the current SG&A expense as a percentage of revenues.

Interest Incurred

We capitalize interest costs incurred to inventory during active development and construction (active inventory). Capitalized interest is charged to cost of sales as the related inventory is delivered to the buyer. Interest incurred by our homebuilding operations decreased 9% to $109.9 million in fiscal 2018 and decreased 16% to $120.8 million in fiscal 2017 compared to the respective prior years. These decreases were due to decreases in our average homebuilding debt of 4% and 12% in fiscal 2018 and 2017, respectively, and lower average interest rates on our outstanding homebuilding debt during the periods. Interest charged to cost of sales was 1.1%, 1.4% and 1.8% of total cost of sales (excluding inventory and land option charges) in fiscal 2018, 2017 and 2016, respectively.

Other Income

Other income, net of other expenses, included in our homebuilding operations was $7.2 million, $11.0 million and $8.2 million in fiscal 2018, 2017 and 2016, respectively. Other income consists of interest income, rental income and various other types of ancillary income, gains, expenses and losses not directly associated with sales of homes, land and lots. The activities that result in this ancillary income or expense are not significant, either individually or in the aggregate.

Goodwill Impairment

We perform our annual goodwill impairment evaluation in the fourth quarter of each fiscal year. As a result of the 2018 and 2017 evaluations, no impairment charges were recorded. As a result of the 2016 evaluation, a $7.2 million impairment charge was recorded to reduce the goodwill in the Huntsville operating segment in our Southeast reporting region. This operating segment had experienced lower levels of profitability than anticipated primarily due to difficult market conditions.

Business Acquisitions

On October 5, 2017, we acquired 75% of the outstanding shares of Forestar for $558.3 million in cash, pursuant to the terms of the June 2017 merger agreement. Forestar is a publicly traded residential lot development company listed on the New York Stock Exchange under the ticker symbol “FOR,” with operations in 24 markets and 14 states as of September 30, 2018. The transaction costs incurred by us related to this acquisition totaled $7.2 million, of which $5.3 million was incurred during fiscal 2018 and expensed to homebuilding selling, general and administrative expense.

Our alignment with Forestar advances our strategy of increasing our access to optioned land and lot positions to enhance operational efficiency and returns. At September 30, 2018, Forestar owned approximately 18,200 lots and controlled an additional 1,900 lots through option contracts. Of Forestar’s total 20,100 lots owned and controlled, 13,600 lots were under contract or subject to a right of first offer with our homebuilding segment. Both our homebuilding divisions and Forestar are identifying land development opportunities to expand Forestar’s platform, and our homebuilding operations are acquiring finished lots from Forestar in accordance with the master supply agreement between the two companies. As the controlling shareholder of Forestar, we strongly influence the strategic direction, growth plans and operational execution necessary to increase the future value potential of Forestar.

In September 2016, we acquired the homebuilding operations of Wilson Parker Homes for $91.9 million. Wilson Parker Homes operated in Atlanta and Augusta, Georgia; Raleigh, North Carolina; Columbia, South Carolina and Phoenix, Arizona. The assets acquired included approximately 380 homes in inventory, 490 lots and control of approximately 1,850 additional lots through option contracts. We also acquired a sales order backlog of 308 homes valued at $74.1 million.

In June 2018, we acquired the assets of Permian Homes, which included a $44.2 million sales order backlog of 159 homes. Permian Homes operates in Midland and Odessa, Texas. This asset purchase was not material to our results of operations or our financial condition.

Homebuilding Results by Reporting Region

		Fiscal Year Ended September 30,
		Homebuilding Revenues												Homebuilding Pre-tax Income (1)												Pre-tax Income as a Percentage of Homebuilding Revenues
		2018				2017				2016				2018				2017				2016				2018			2017			2016
East		$	1,893.4			$	1,640.1			$	1,446.5			$	217.3			$	153.9			$	138.7			11.5	%		9.4	%		9.6	%
Midwest		858.9				736.5				651.7				77.5				49.1				44.3				9.0	%		6.7	%		6.8	%
Southeast		4,578.6				4,087.6				3,463.5				536.0				450.3				388.4				11.7	%		11.0	%		11.2	%
South Central		3,769.9				3,383.1				2,995.1				506.1				439.1				374.8				13.4	%		13.0	%		12.5	%
Southwest		768.7				597.5				388.1				97.4				39.6				7.3				12.7	%		6.6	%		1.9	%
West		3,754.3				3,296.7				2,916.9				522.9				357.3				310.9				13.9	%		10.8	%		10.7	%
		$	15,623.8			$	13,741.5			$	11,861.8			$	1,957.2			$	1,489.3			$	1,264.4			12.5	%		10.8	%		10.7	%

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(1)

Expenses maintained at the corporate level consist primarily of interest and property taxes, which are capitalized and amortized to cost of sales or expensed directly, and the expenses related to operating our corporate office. The amortization of capitalized interest and property taxes is allocated to each segment based on the segment’s cost of sales, while expenses associated with the corporate office are allocated to each segment based on the segment’s inventory balances.

2018 versus 2017

East Region — Homebuilding revenues increased 15% in fiscal 2018 compared to fiscal 2017, primarily due to an increase in the number of homes closed in our Carolina markets. The region generated pre-tax income of $217.3 million in 2018, compared to $153.9 million in 2017. Gross profit from home sales as a percentage of home sales revenue (home sales gross profit percentage) increased by 130 basis points in 2018 compared to 2017, due to a decrease in the average cost of homes closed. Pre-tax income was reduced by inventory and land option charges of $2.3 million and $13.6 million in 2018 and 2017, respectively, primarily in our North Carolina markets in 2018 and in our suburban Washington, D.C. market in 2017. As a percentage of homebuilding revenues, SG&A expenses decreased by 10 basis points in 2018 compared to 2017.

Midwest Region — Homebuilding revenues increased 17% in fiscal 2018 compared to fiscal 2017, primarily due to increases in the number of homes closed and the average selling price in our Denver market as well as an increase in the number of homes closed in our Minneapolis/St. Paul market. The region generated pre-tax income of $77.5 million in 2018, compared to $49.1 million in 2017. Home sales gross profit percentage increased by 250 basis points in 2018 compared to 2017, largely due to lower warranty and construction defect costs. Pre-tax income was reduced by inventory and land option charges of $5.1 million and $1.8 million in 2018 and 2017, respectively, primarily in our Minnesota market in 2018 and in our Denver market in 2017. As a percentage of homebuilding revenues, SG&A expenses decreased by 30 basis points in 2018 compared to 2017, primarily due to the increase in homebuilding revenues.

Southeast Region — Homebuilding revenues increased 12% in fiscal 2018 compared to fiscal 2017, primarily due to an increase in the number of homes closed in our Florida markets. The region generated pre-tax income of $536.0 million in 2018, compared to $450.3 million in 2017. The region’s fiscal 2018 results include a $24.5 million inventory and land option charge related to the settlement of an outstanding dispute associated with a land transaction and a $13.4 million gain on the sale of multi-family rental units in one community. Home sales gross profit percentage increased by 50 basis points in 2018 compared to 2017, due to the average selling price of homes closed increasing by more than the average cost. As a percentage of homebuilding revenues, SG&A expenses decreased by 30 basis points in 2018 compared to 2017, primarily due to the increase in homebuilding revenues.

South Central Region — Homebuilding revenues increased 11% in fiscal 2018 compared to fiscal 2017, primarily due to an increase in the number of homes closed in our Dallas, Fort Worth and Louisiana markets. The region generated pre-tax income of $506.1 million in 2018, compared to $439.1 million in 2017. Home sales gross profit percentage increased by 40 basis points in 2018 compared to 2017, due to the average cost of homes closed decreasing by more than the average selling price. As a percentage of homebuilding revenues, SG&A expenses decreased by 10 basis points in 2018 compared to 2017.

Southwest Region — Homebuilding revenues increased 29% in fiscal 2018 compared to fiscal 2017, primarily due to an increase in the number of homes closed in our Phoenix market. The region generated pre-tax income of $97.4 million in 2018, compared to $39.6 million in 2017. Home sales gross profit percentage increased by 430 basis points in 2018 compared to 2017, primarily due to an increase in the average selling price of homes closed and a decrease in the average cost of those homes, as well as a $15.8 million decrease in warranty and construction defect costs related to a community in our Albuquerque market. The region’s fiscal 2018 results include $13.1 million of profit generated from a land sale in our Phoenix market. As a percentage of homebuilding revenues, SG&A expenses decreased by 60 basis points in 2018 compared to 2017, primarily due to the increase in homebuilding revenues.

West Region — Homebuilding revenues increased 14% in fiscal 2018 compared to fiscal 2017, primarily due to an increase in the number of homes closed in our Northern California, Salt Lake City, Seattle and Hawaii markets. The region generated pre-tax income of $522.9 million in 2018, compared to $357.3 million in 2017. Home sales gross profit percentage increased by 280 basis points in 2018 compared to 2017, primarily due to the average cost of homes closed decreasing by more than the average selling price. As a percentage of homebuilding revenues, SG&A expenses decreased by 40 basis points in 2018 compared to 2017, primarily due to the increase in homebuilding revenues.

2017 versus 2016

East Region — Homebuilding revenues increased 13% in fiscal 2017 compared to fiscal 2016, primarily due to an increase in the number of homes closed in our North and South Carolina markets. The region generated pre-tax income of $153.9 million in 2017, compared to $138.7 million in 2016. Pre-tax income was reduced by inventory impairment charges of $10.5 million and $12.3 million in 2017 and 2016, respectively, primarily in our suburban Washington, D.C. markets during 2017 and in our New Jersey market during 2016. Gross profit from home sales as a percentage of home sales revenue (home sales gross profit percentage) decreased by 30 basis points in 2017 compared to 2016. As a percentage of homebuilding revenues, SG&A expenses increased by 20 basis points in 2017 compared to 2016.

Midwest Region — Homebuilding revenues increased 13% in fiscal 2017 compared to fiscal 2016, primarily due to an increase in the number of homes closed in our Minneapolis and Denver markets. The region generated pre-tax income of $49.1 million in 2017, compared to $44.3 million in 2016. Home sales gross profit percentage decreased by 80 basis points in 2017 compared to 2016, largely due to higher warranty and construction defect costs in our Denver market. As a percentage of homebuilding revenues, SG&A expenses decreased by 70 basis points in 2017 compared to 2016.

Southeast Region — Homebuilding revenues increased 18% in fiscal 2017 compared to fiscal 2016, primarily due to an increase in the number of homes closed in our Florida markets. The region generated pre-tax income of $450.3 million in 2017, compared to $388.4 million in 2016. Home sales gross profit percentage decreased by 60 basis points in 2017 compared to 2016, due to the average cost of homes closed increasing by more than the average selling price. As a percentage of homebuilding revenues, SG&A expenses decreased by 30 basis points in 2017 compared to 2016.

South Central Region — Homebuilding revenues increased 13% in fiscal 2017 compared to fiscal 2016, primarily due to an increase in the number of homes closed in our Dallas market. The region generated pre-tax income of $439.1 million in 2017, compared to $374.8 million in 2016. Home sales gross profit percentage decreased by 20 basis points in 2017 compared to 2016. As a percentage of homebuilding revenues, SG&A expenses decreased by 70 basis points in 2017 compared to 2016.

Southwest Region — Homebuilding revenues increased 54% in fiscal 2017 compared to fiscal 2016, primarily due to an increase in the number of homes closed in our Phoenix market, as well as an increase in the average selling price of those homes. The region generated pre-tax income of $39.6 million in 2017, compared to $7.3 million in 2016. Pre-tax income in 2016 was reduced by inventory impairment charges of $6.0 million in our Phoenix market. Home sales gross profit percentage increased by 210 basis points in 2017 compared to 2016, primarily due to the average selling price of homes closed increasing while the average cost decreased. The increase was also due to lower fiscal 2017 warranty and construction defect costs in our Phoenix market. As a percentage of homebuilding revenues, SG&A expenses decreased by 170 basis points in 2017 compared to 2016, primarily due to the significant increase in homebuilding revenues.

West Region — Homebuilding revenues increased 13% in fiscal 2017 compared to fiscal 2016, primarily due to an increase in the number of homes closed in our Las Vegas and northern California markets, as well as increases in the average selling price of homes closed in our Seattle, Portland and Sacramento markets. The region generated pre-tax income of $357.3 million in 2017, compared to $310.9 million in 2016. Home sales gross profit percentage increased by 20 basis points in 2017 compared to 2016. As a percentage of homebuilding revenues, SG&A expenses decreased by 20 basis points in 2017 compared to 2016.

Homebuilding Inventories, Land and Lot Position and Homes in Inventory

We routinely enter into land/lot option contracts to purchase land or developed residential lots at predetermined prices on a defined schedule commensurate with planned development or anticipated new home demand. We also purchase undeveloped land that generally is vested with the rights to begin development or construction work, and we plan and coordinate the development of our land into residential lots for use in our homebuilding business. We manage our inventory of owned land and lots and homes under construction relative to demand in each of our markets, including starting construction on unsold homes to capture new home demand and actively controlling the number of unsold, completed homes in inventory.

Our homebuilding segment’s inventories at September 30, 2018 and 2017 are summarized as follows:

	September 30, 2018
	Construction in Progress and Finished Homes				Residential Land/Lots Developed and Under Development				Land Held for Development				Land Held for Sale				Total Inventory
	(In millions)
East	$	648.6			$	529.5			$	10.1			$	3.8			$	1,192.0
Midwest	369.9				208.0				1.8				3.4				583.1
Southeast	1,388.4				1,248.5				31.5				0.3				2,668.7
South Central	1,222.5				1,216.3				0.3				0.3				2,439.4
Southwest	194.8				303.2				1.7				—				499.7
West	1,146.5				1,076.1				14.4				31.5				2,268.5
Corporate and unallocated (1)	113.7				107.7				1.4				0.9				223.7
	$	5,084.4			$	4,689.3			$	61.2			$	40.2			$	9,875.1

	September 30, 2017
	Construction in Progress and Finished Homes				Residential Land/Lots Developed and Under Development				Land Held for Development				Land Held for Sale				Total Inventory
	(In millions)
East	$	569.3			$	478.1			$	21.0			$	0.5			$	1,068.9
Midwest	335.8				155.0				1.8				—				492.6
Southeast	1,265.6				1,085.0				35.9				5.8				2,392.3
South Central	1,050.8				1,132.6				14.1				1.9				2,199.4
Southwest	203.9				299.5				2.7				—				506.1
West	1,070.0				1,257.3				23.2				2.0				2,352.5
Corporate and unallocated (1)	110.6				112.2				2.3				0.2				225.3
	$	4,606.0			$	4,519.7			$	101.0			$	10.4			$	9,237.1

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(1)	Corporate and unallocated inventory consists primarily of capitalized interest and property taxes.

Our homebuilding segment’s land and lot position and homes in inventory at September 30, 2018 and 2017 are summarized as follows:

	September 30, 2018
	Land/Lots Owned (1)			Lots Controlled Under Land and Lot Option Purchase Contracts (2)(3)			Total Land/Lots Owned and Controlled			Homes in Inventory (4)
East	11,900			19,400			31,300			4,000
Midwest	3,800			9,300			13,100			1,800
Southeast	37,100			70,400			107,500			9,500
South Central	42,900			45,700			88,600			8,800
Southwest	7,600			5,000			12,600			1,500
West	21,000			14,400			35,400			4,100
	124,300			164,200			288,500			29,700
	43	%		57	%		100	%

	September 30, 2017
	Land/Lots Owned (1)			Lots Controlled Under Land and Lot Option Purchase Contracts (2)(3)			Total Land/Lots Owned and Controlled			Homes in Inventory (4)
East	13,200			17,800			31,000			3,500
Midwest	2,600			4,400			7,000			1,500
Southeast	35,800			47,500			83,300			8,500
South Central	42,800			38,700			81,500			7,300
Southwest	8,700			2,400			11,100			1,700
West	21,900			13,200			35,100			3,700
	125,000			124,000			249,000			26,200
	50	%		50	%		100	%

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(1)	Land/lots owned include approximately 35,100 and 33,200 owned lots that are fully developed and ready for home construction at September 30, 2018 and 2017, respectively. Land/lots owned also include land held for development representing 1,700 and 4,800 lots at September 30, 2018 and 2017, respectively.

(2)

The total remaining purchase price of lots controlled through land and lot option purchase contracts at September 30, 2018 and 2017 was $6.5 billion and $4.6 billion, respectively, secured by earnest money deposits of $401.1 million and $227.6 million, respectively. The total remaining purchase price of lots controlled at September 30, 2018 included $522.2 million related to lot option contracts with Forestar, secured by $48.0 million of earnest money.

(3)

Lots controlled at September 30, 2018 include approximately 13,600 lots owned or controlled by Forestar, 5,500 of which our homebuilding divisions have under contract to purchase and 8,100 of which our homebuilding divisions have a right of first offer to purchase. Of these, approximately 5,100 lots were in our Southeast region, 3,700 lots were in our South Central region, 2,600 lots were in our West region, 1,400 lots were in our East region, 400 lots were in our Midwest region and 400 lots were in our Southwest region.

(4)

Homes in inventory include approximately 1,800 and 1,600 model homes at September 30, 2018 and 2017, respectively. Approximately 16,400 and 13,800 of our homes in inventory were unsold at September 30, 2018 and 2017, respectively. At September 30, 2018, approximately 4,000 of our unsold homes were completed, of which approximately 400 homes had been completed for more than six months. At September 30, 2017, approximately 4,100 of our unsold homes were completed, of which approximately 500 homes had been completed for more than six months.

Results of Operations — Forestar

On October 5, 2017, we acquired 75% of the outstanding shares of Forestar. Forestar’s segment results are presented on their historical cost basis, consistent with the manner in which management evaluates segment performance. (See Note B for additional Forestar segment information and purchase accounting adjustments.)

Results of operations for the Forestar segment from the date of acquisition through September 30, 2018 (referred to as fiscal 2018 in the discussion below) were as follows:

		For the Period from October 5, 2017 to September 30, 2018
		(In millions)
Residential land and lot sales		$	100.1
Commercial lot sales		9.1
Total revenues		$	109.2
Cost of sales		69.0
Selling, general and administrative expense		32.8
Equity in earnings of unconsolidated entities		(12.4		)
Gain on sale of assets		(27.7		)
Interest expense		5.8
Other (income) expense		(7.0		)
Income before income taxes		$	48.7

Residential land and lot sales primarily consist of the sale of single-family lots to local, regional and national homebuilders. During fiscal 2018, Forestar sold 1,279 single-family lots from its owned projects and consolidated ventures at an average sales price of $77,800. During fiscal 2018, Forestar sold 642 lots to D.R. Horton for $37.1 million and sold 79 residential tract acres to D.R. Horton for $2.0 million.

Selling, general and administrative (SG&A) expense for fiscal 2018 includes $6.3 million of severance and change of control charges for Forestar’s executive officers that were triggered shortly after the acquisition date. The severance and change of control amount of $2.6 million was payable to Forestar’s former Chief Executive Officer upon his resignation from Forestar on December 28, 2017. The remaining severance and change of control amounts are payable upon termination or resignation of each of the executives. SG&A expense also includes charges of $0.9 million related to the shared services agreement between Forestar and D.R. Horton whereby D.R. Horton provides Forestar with certain administrative, compliance, operational and procurement services.

Equity in earnings of unconsolidated entities for fiscal 2018 primarily relates to the sale of a multi-family joint venture project in Nashville, Tennessee.

On February 8, 2018, Forestar sold a portion of its assets for $232 million. This strategic asset sale included projects owned both directly and indirectly through ventures and consisted of approximately 750 developed and under development lots, over 4,000 future undeveloped lots, 730 unentitled acres, an interest in one multi-family operating property and a multi-family development site. The total net proceeds after certain purchase price adjustments, closing costs and other costs associated with selling these projects was $217.5 million, and a gain on the sale of these assets of $0.7 million is included in our consolidated statement of operations for fiscal 2018.

Gain on sale of assets during fiscal 2018 also included gains of $14.6 million related to the sale of Forestar’s interest in a multi-family venture and $9.1 million related to the sale of water rights in East Texas.

At September 30, 2018, Forestar owned directly or controlled through land and lot option purchase contracts approximately 20,100 residential lots, of which approximately 1,600 are fully developed. Approximately 13,600 of these lots are under contract to sell to D.R. Horton or subject to a right of first offer under the master supply agreement with D.R. Horton. Approximately 300 of these lots are under contract to sell to other builders.

Results of Operations — Financial Services

The following tables and related discussion set forth key operating and financial data for our financial services operations, comprising DHI Mortgage and our subsidiary title companies, for the fiscal years ended September 30, 2018, 2017 and 2016.

		Fiscal Year Ended September 30,									2018 vs 2017			2017 vs 2016
		2018			2017			2016
Number of first-lien loans originated or brokered by DHI Mortgage for D.R. Horton homebuyers		29,133			25,488			21,970			14	%		16	%
Number of homes closed by D.R. Horton		51,857			45,751			40,309			13	%		14	%
Percentage of D.R. Horton homes financed by DHI Mortgage		56	%		56	%		55	%
Number of total loans originated or brokered by DHI Mortgage for D.R. Horton homebuyers		29,234			25,677			22,127			14	%		16	%
Total number of loans originated or brokered by DHI Mortgage		30,107			27,002			23,920			11	%		13	%
Captive business percentage		97	%		95	%		93	%
Loans sold by DHI Mortgage to third parties		29,120			27,251			23,926			7	%		14	%

		Fiscal Year Ended September 30,												2018 vs 2017			2017 vs 2016
		2018				2017				2016
		(In millions)
Loan origination fees		$	15.0			$	17.7			$	20.1			(15	)%		(12	)%
Sale of servicing rights and gains from sale of mortgage loans		265.1				251.1				207.5				6	%		21	%
Other revenues		18.7				16.5				14.6				13	%		13	%
Total mortgage operations revenues		298.8				285.3				242.2				5	%		18	%
Title policy premiums		76.5				64.2				53.4				19	%		20	%
Total revenues		375.3				349.5				295.6				7	%		18	%
General and administrative expense (1)		272.6				239.3				211.2				14	%		13	%
Other (income) expense (1)		(15.1		)		(14.3		)		(13.7		)		6	%		4	%
Financial services pre-tax income		$	117.8			$	124.5			$	98.1			(5	)%		27	%

Financial Services Operating Margin Analysis

		Percentages of Financial Services Revenues
		Fiscal Year Ended September 30,
		2018			2017			2016
General and administrative expense (1)		72.6	%		68.5	%		71.4	%
Other (income) expense (1)		(4.0	)%		(4.1	)%		(4.6	)%
Financial services pre-tax income		31.4	%		35.6	%		33.2	%

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(1)	General and administrative expense of $11.9 million and $8.8 million, other income of $0.2 million and other expense of $0.2 million related to our other business activities were excluded from the fiscal 2017 and 2016 amounts, respectively, to conform to the current year presentation.

Mortgage Loan Activity

The volume of loans originated by our mortgage operations is directly related to the number of homes closed by our homebuilding operations. In fiscal 2018 and 2017, the volume of first-lien loans originated or brokered by DHI Mortgage for our homebuyers increased 14% and 16% from the respective prior years, primarily as a result of increases in the number of homes closed by our homebuilding operations of 13% and 14%, respectively. The percentage of homes closed for which DHI Mortgage handled the homebuyers’ financing was 56% in fiscal 2018 and 2017 and 55% in fiscal 2016.

Homes closed by our homebuilding operations constituted 97%, 95% and 93% of DHI Mortgage loan originations in fiscal 2018, 2017 and 2016, respectively. These percentages reflect DHI Mortgage’s consistent focus on the captive business provided by our homebuilding operations.

The number of loans sold increased 7% in fiscal 2018 and 14% in fiscal 2017 compared to the respective prior years. Virtually all of the mortgage loans held for sale on September 30, 2018 were eligible for sale to Fannie Mae, Freddie Mac or Ginnie Mae. Approximately 92% of the mortgage loans sold by DHI Mortgage during fiscal 2018 were sold to four major financial entities, the largest percentage of which purchased 36% of the total loans sold.

Financial Services Revenues and Expenses

Revenues from our financial services operations increased 7% to $375.3 million in fiscal 2018 from $349.5 million in fiscal 2017, while the number of loan originations increased 11% over that same period. Revenues from our financial services operations increased 18% to $349.5 million in fiscal 2017 from $295.6 million in fiscal 2016, while the number of loan originations increased 13%. In fiscal 2018, revenues increased at a lower rate than origination volume primarily due to lower pricing and resulting net gains on loan origination sales due to competitive pressures in the mortgage market. In fiscal 2017, revenues increased at a higher rate than origination volume primarily due to improved loan sale execution in the secondary market and increased revenue from title operations.

Our mortgage operations revenues were reduced by $1.3 million, $2.9 million and $8.5 million in fiscal 2018, 2017 and 2016, respectively, to increase our loss reserves for estimated future recourse obligations and other mortgage loans, and to adjust certain mortgage loans held for sale to fair value. Our loss reserves for loan recourse obligations are estimated based upon analysis of the volume of mortgages originated, loan repurchase requests received, actual repurchases and losses through the disposition of such loans or requests and discussions with our mortgage purchasers. Actual losses on mortgage loans may differ from our estimates, which may result in future changes to our loss reserves.

General and administrative (G&A) expense related to financial services operations was $272.6 million, $239.3 million and $211.2 million in fiscal 2018, 2017 and 2016, respectively, increasing 14% in 2018 and 13% in 2017 from the respective prior years. These increases were primarily due to increases in employee related costs due to increased volume. Our financial services operations employed 1,919, 1,798 and 1,575 employees at September 30, 2018, 2017 and 2016, respectively.

As a percentage of financial services revenues, G&A expense was 72.6%, 68.5% and 71.4% in fiscal 2018, 2017 and 2016, respectively. The increase in the current year was primarily due to lower pricing and resulting net gains on loan origination sales resulting in reduced revenue relative to origination volume. Fluctuations in financial services G&A expense as a percentage of revenues can be expected to occur, as some components of revenue may fluctuate differently than loan volumes, and some expenses are not directly related to mortgage loan volume or to changes in the amount of revenue earned.

Other income, net of other expense, included in our financial services operations consists primarily of the interest income of our mortgage subsidiary.

Results of Operations — Consolidated

Income before Income Taxes

Pre-tax income was $2.1 billion, $1.6 billion and $1.4 billion in fiscal 2018, 2017 and 2016, respectively. The increase in our pre-tax income over the three-year period is primarily due to higher revenues from increased home closings and an increase in home sales gross profit.

Income Taxes

Our income tax expense was $597.7 million, $563.7 million and $467.2 million in fiscal 2018, 2017 and 2016, respectively, and our effective tax rate was 29.0%, 35.2% and 34.5% in those years. The effective tax rate for fiscal 2018 reflects the impact of the Tax Cuts and Jobs Act (Tax Act), which was enacted into law on December 22, 2017, an excess tax benefit related to stock-based compensation, the release of a valuation allowance against deferred tax assets related to Forestar, and the enactment of the Bipartisan Budget Act of 2018, which retroactively extended the expiration date of the federal energy efficient home credit from December 31, 2016 until December 31, 2017. The effective tax rates for all years include an expense for state income taxes, reduced by tax benefits for the domestic production activities deduction.

The Tax Act reduced the corporate tax rate from 35% to 21% for all corporations effective January 1, 2018. For fiscal year companies, the change in law requires the application of a blended tax rate in the year of change, which for us was 24.5% for the fiscal year ended September 30, 2018. Thereafter, the applicable statutory tax rate is 21%. ASC 740 requires all companies to reflect the effects of the new law in the period in which the law was enacted. Accordingly, we reduced the statutory tax rate that applied to our year-to-date earnings from 35% to 24.5%. In addition, we remeasured our deferred tax assets and liabilities for the tax law change, which resulted in additional income tax expense of $108.7 million recognized during the three months ended December 31, 2017. No other tax law changes as a result of the Tax Act had a significant impact on our financial statements. Our deferred tax assets, net of deferred tax liabilities, were $211.7 million at September 30, 2018 compared to $376.2 million at September 30, 2017.

On October 5, 2017, we acquired 75% of the outstanding shares of Forestar. We recorded goodwill of $29.2 million, which is not deductible for income tax purposes. At the acquisition date, we recorded a valuation allowance of $20.1 million against Forestar’s $20.4 million of deferred tax assets due to Forestar’s cumulative losses in recent years. During the fourth quarter of fiscal 2018, Forestar emerged from the cumulative loss position. We evaluated all positive and negative evidence and determined the emergence from the cumulative loss position and other positive evidence outweighed the negative evidence, and reduced the valuation allowance which resulted in a corresponding reduction in income tax expense. As of September 30, 2018, we have retained a valuation allowance of $3.5 million related to Forestar’s state deferred tax assets for net operating loss (NOL) carryforwards that are more likely than not to expire before being realized.

In addition to the $3.5 million valuation allowance related to Forestar’s state deferred tax assets, we have a valuation allowance of $14.2 million related to D.R. Horton’s state deferred tax assets for net operating loss (NOL) carryforwards because it is more likely than not that a portion of the state NOL carryforwards will expire before being realized. In total, our valuation allowance was $17.7 million at September 30, 2018 and $11.2 million at September 30, 2017. We will continue to evaluate both the positive and negative evidence in determining the need for a valuation allowance with respect to our remaining state NOL carryforwards. Any reversal of the valuation allowance in future periods will impact our effective tax rate.

D.R. Horton has $19.3 million of tax benefits for state NOL carryforwards that expire at various times depending on the tax jurisdiction. Of the total amount, $5.4 million of the tax benefits expire over the next ten years and the remaining $13.9 million expires from fiscal years 2029 to 2038.

Forestar has $14.8 million of tax benefits for federal NOL carryforwards, after consideration of intra-entity profit eliminations, which have no expiration date. Additionally, Forestar has $4.0 million of tax benefits for state NOL carryforwards that expire at various times depending on the tax jurisdiction.

The accounting for deferred taxes is based upon estimates of future results. Differences between the anticipated and actual outcomes of these future results could have a material impact on our consolidated results of operations or financial position. Also, changes in existing federal and state tax laws and tax rates could affect future tax results and the valuation of our deferred tax assets.

D.R. Horton is subject to federal income tax and to income tax in multiple states. The statute of limitations for D.R. Horton’s major tax jurisdictions remains open for examination for fiscal years 2015 through 2018. D.R. Horton is currently being audited by various states; however, to date, we are not aware of any significant findings identified by the taxing authorities.

Forestar is subject to federal income tax and to income tax in multiple states. All federal statutes of limitations for tax years prior to 2016 are effectively closed. The statute of limitations in major state jurisdictions for tax years prior to 2014 is closed. Forestar is currently under audit by the IRS for the 2016 tax year. At this time, Forestar is not aware of any significant findings identified by the IRS. Forestar is not currently being audited by any state jurisdictions.

Capital Resources and Liquidity

We have historically funded our operations with cash flows from operating activities, borrowings under bank credit facilities and the issuance of new debt securities. Our current levels of cash, borrowing capacity and balance sheet leverage provide us with the operational flexibility to adjust to changes in market conditions and allow us to increase our investments in homes, finished lots, land and land development to expand our operations and grow our profitability.

At September 30, 2018, our ratio of debt to total capital (notes payable divided by stockholders’ equity plus notes payable) was 26.3% compared to 27.0% at September 30, 2017. Our ratio of homebuilding debt to total capital (homebuilding notes payable divided by stockholders’ equity plus homebuilding notes payable) was 21.4% compared to 24.0% at September 30, 2017. Over the long term, we intend to maintain our ratio of homebuilding debt to total capital below 35%, and we expect it to remain significantly lower than 35% throughout fiscal 2019. We believe that the ratio of homebuilding debt to total capital is useful in understanding the leverage employed in our homebuilding operations and comparing our capital structure with other homebuilders. We exclude the debt of Forestar and our financial services business because they are separately capitalized and not guaranteed by our parent company or any of our homebuilding entities.

We regularly assess our projected capital requirements to fund growth in our business, repay debt obligations, and support other general corporate and operational needs, and we regularly evaluate our opportunities to raise additional capital. We have an automatically effective universal shelf registration statement filed with the SEC in August 2018, registering debt and equity securities that we may issue from time to time in amounts to be determined. Also, Forestar has an effective shelf registration statement filed with the SEC in September 2018, registering $500 million of equity securities. As market conditions permit, we may issue new debt or equity securities through the capital markets or obtain additional bank financing to fund our projected capital requirements or provide additional liquidity. We believe that our existing cash resources, revolving credit facilities, mortgage repurchase facility and ability to access the capital markets will provide sufficient liquidity to fund our near-term working capital needs and debt obligations, including the maturity of $500 million principal amount of senior notes in fiscal 2019.

Capital Resources - Homebuilding

Cash and Cash Equivalents — At September 30, 2018, cash and cash equivalents of our homebuilding segment totaled $1.1 billion.

Bank Credit Facility — We have a senior unsecured homebuilding revolving credit facility which was amended in September 2018 to increase its capacity from $1.275 billion to $1.325 billion and to extend its maturity date to September 25, 2023. The facility has an uncommitted accordion feature that could increase the size of the facility to $1.9 billion, subject to certain conditions and availability of additional bank commitments. The facility also provides for the issuance of letters of credit with a sublimit equal to approximately 50% of the revolving credit commitment. Letters of credit issued under the facility reduce the available borrowing capacity. The interest rate on borrowings under the revolving credit facility may be based on either the Prime Rate or London Interbank Offered Rate (LIBOR) plus an applicable margin, as defined in the credit agreement governing the facility. Borrowings and repayments under the facility totaled $1.8 billion each during fiscal 2018. At September 30, 2018, there were no borrowings outstanding and $107.2 million of letters of credit issued under the revolving credit facility, resulting in available capacity of approximately $1.2 billion.

Our homebuilding revolving credit facility imposes restrictions on our operations and activities, including requiring the maintenance of a maximum allowable ratio of debt to tangible net worth and a borrowing base restriction if our ratio of debt to tangible net worth exceeds a certain level. These covenants are measured as defined in the credit agreement governing the facility and are reported to the lenders quarterly. A failure to comply with these financial covenants could allow the lending banks to terminate the availability of funds under the revolving credit facility or cause any outstanding borrowings to become due and payable prior to maturity. The credit agreement governing the facility imposes restrictions on the creation of secured debt and liens. At September 30, 2018, we were in compliance with all of the covenants, limitations and restrictions of our homebuilding revolving credit facility.

Public Unsecured Debt — We have $2.45 billion principal amount of homebuilding senior notes outstanding as of September 30, 2018 that mature from fiscal 2019 through fiscal 2023. $500 million principal amount of our senior notes mature in March 2019. In December 2017, we issued $400 million principal amount of 2.55% senior notes due December 1, 2020, with interest payable semi-annually. The annual effective interest rate of these notes after giving effect to the amortization of financing costs is 2.8%. In December 2017, we redeemed $400 million principal amount of our 3.625% senior notes due February 2018. The senior notes were redeemed at a price equal to 100% of the principal amount of the notes, together with accrued and unpaid interest. The indenture governing our senior notes imposes restrictions on the creation of secured debt and liens. At September 30, 2018, we were in compliance with all of the limitations and restrictions associated with our public debt obligations.

Repurchases of Common Stock — During fiscal 2018, we repurchased 2.8 million shares of our common stock for $127.5 million.

Debt and Equity Repurchase Authorizations — Effective August 1, 2018, our Board of Directors authorized the repurchase of up to $500 million of debt securities and $400 million of our common stock effective through September 30, 2019. The full amount of the debt authorization was remaining at September 30, 2018. During August 2018, we repurchased 560,000 shares of our common stock for $24.5 million, resulting in a remaining equity authorization of $375.5 million at September 30, 2018.

Capital Resources - Forestar

At September 30, 2018, Forestar had cash and cash equivalents of $318.8 million. In August 2018, Forestar entered into a $380 million senior unsecured bank credit facility. Forestar’s cash position and borrowing capacity under its bank credit facility is expected to be sufficient to fund its growth objectives and working capital needs in the short-term. In September 2018, Forestar filed an effective shelf registration statement with the SEC, registering $500 million of equity securities. The liquidity of Forestar and its ability to achieve longer term growth objectives will depend on its ability to generate cash from operations and to obtain financing in sufficient capacities. As market conditions permit, Forestar may issue new debt or equity securities through the capital markets or obtain additional bank financing to provide capital for future growth and additional liquidity. Forestar plans to access the capital markets in fiscal 2019 to support its long-term growth.

Bank Credit Facility — In August 2018, Forestar entered into a $380 million senior unsecured revolving credit facility with an uncommitted accordion feature that could increase the size of the facility to $570 million, subject to certain conditions and availability of additional bank commitments. The facility also provides for the issuance of letters of credit with a sublimit equal to the greater of $100 million and 50% of the revolving credit commitment. Borrowings under the revolving credit facility are subject to a borrowing base based on Forestar’s book value of its real estate assets and unrestricted cash. The maturity date of the facility is August 16, 2021. The maturity date of the revolving credit facility may be extended by up to one year on up to three occasions, subject to the approval of lenders holding a majority of the commitments. At September 30, 2018, there were no borrowings outstanding and $4.5 million of letters of credit issued under the revolving credit facility, resulting in available capacity of $375.5 million.

The revolving credit facility includes customary affirmative and negative covenants, events of default and financial covenants. The financial covenants require Forestar to maintain a minimum level of tangible net worth, a minimum level of liquidity and a maximum allowable leverage ratio. These covenants are measured as defined in the credit agreement governing the facility and are reported to the lenders quarterly. A failure to comply with these financial covenants could allow the lending banks to terminate the availability of funds under the revolving credit facility or cause any outstanding borrowings to become due and payable prior to maturity. At September 30, 2018, Forestar was in compliance with all of the covenants, limitations and restrictions of its revolving credit facility.

Letter of Credit Facility — In August 2018, in connection with entering into the revolving credit facility agreement, Forestar amended its letter of credit facility agreement. Under the amendment, outstanding letters of credit issued by one bank were transferred into Forestar’s new revolving credit facility. The amendment reduced the capacity of the letter of credit facility from $30.0 million to $15.4 million and provided for a corresponding release of cash collateral in the amount of $13.8 million. The amendment also extended the maturity date of the facility to October 5, 2019. At September 30, 2018, letters of credit outstanding under the letter of credit facility totaled $15.4 million, secured by $16.2 million in cash, which is included in restricted cash in the consolidated balance sheet.

Public Unsecured Debt — On October 5, 2017, Forestar had $120 million principal amount outstanding of 3.75% convertible senior notes due 2020. The completion of the acquisition resulted in a fundamental change in the notes as described in the related note indentures and therefore, Forestar offered to purchase all or any part of every holder’s convertible senior notes for a price in cash equal to 100% of the aggregate principal amount of the notes, plus accrued and unpaid interest, if any, to the date of repurchase. As a result, Forestar purchased $1.1 million of the aggregate principal amount of the notes. Also, prior to the acquisition, upon conversion of the notes each holder was entitled to receive 40.8351 shares of former Forestar common stock per $1,000 principal amount of notes surrendered for conversion. In connection with the acquisition, the conversion ratio was adjusted in accordance with the indenture governing the convertible notes such that each holder is now entitled to receive $579.77062 in cash and 8.17192 shares of new Forestar common stock per $1,000 principal amount of notes surrendered for conversion.

Forestar’s revolving credit facility and its convertible senior notes are not guaranteed by D.R. Horton, Inc. or any of the subsidiaries that guarantee our homebuilding debt.

Capital Resources - Financial Services

Cash and Cash Equivalents — At September 30, 2018, cash and cash equivalents of our financial services operations totaled $33.7 million.

Mortgage Repurchase Facility — Our mortgage subsidiary, DHI Mortgage, has a mortgage repurchase facility that is accounted for as a secured financing. The mortgage repurchase facility provides financing and liquidity to DHI Mortgage by facilitating purchase transactions in which DHI Mortgage transfers eligible loans to the counterparties against the transfer of funds by the counterparties, thereby becoming purchased loans. DHI Mortgage then has the right and obligation to repurchase the purchased loans upon their sale to third-party purchasers in the secondary market or within specified time frames from 45 to 60 days in accordance with the terms of the mortgage repurchase facility. The total capacity of the facility is $600 million; however, the capacity increases, without requiring additional commitments, to $725 million for approximately 30 days at each quarter end and to $800 million for approximately 45 days at fiscal year end. The capacity of the facility can also be increased to $1.0 billion subject to the availability of additional commitments. The maturity date of the facility is February 22, 2019.

As of September 30, 2018, $758.6 million of mortgage loans held for sale with a collateral value of $735.6 million were pledged under the mortgage repurchase facility. As a result of advance paydowns totaling $97.9 million, DHI Mortgage had an obligation of $637.7 million outstanding under the mortgage repurchase facility at September 30, 2018 at a 4.1% annual interest rate.

The mortgage repurchase facility is not guaranteed by D.R. Horton, Inc. or any of the subsidiaries that guarantee our homebuilding debt. The facility contains financial covenants as to the mortgage subsidiary’s minimum required tangible net worth, its maximum allowable ratio of debt to tangible net worth and its minimum required liquidity. These covenants are measured and reported to the lenders monthly. At September 30, 2018, DHI Mortgage was in compliance with all of the conditions and covenants of the mortgage repurchase facility.

In the past, DHI Mortgage has been able to renew or extend its mortgage credit facility at a sufficient capacity and on satisfactory terms prior to its maturity, and obtain temporary additional commitments through amendments to the credit agreement during periods of higher than normal volumes of mortgages held for sale. The liquidity of our financial services business depends upon its continued ability to renew and extend the mortgage repurchase facility or to obtain other additional financing in sufficient capacities.

Operating Cash Flow Activities

In fiscal 2018, net cash provided by operating activities was $545.2 million compared to $440.2 million and $623.9 million in fiscal 2017 and 2016, respectively. Cash provided by operating activities in the current year was primarily due to $1.0 billion of cash provided by our homebuilding segment, partially offset by $330.2 million and $116.6 million of cash used in our Forestar and financial services segments, respectively.

We used $482.8 million of cash to increase our construction in progress and finished home inventory compared to $584.4 million and $496.2 million in fiscal 2017 and 2016, respectively. In each year, the expenditures were made to support the current year increase in sales and closing volumes, as well as the expected increase in the subsequent year. During fiscal 2018, cash used to increase residential land and lots was $573.8 million compared to $362.3 million and $10.3 million in fiscal 2017 and 2016, respectively. The increase in fiscal 2018 was primarily due to cash used to fund land acquisition and development in our Forestar segment. The most significant source of cash provided by operating activities in all years was net income.

Investing Cash Flow Activities

In fiscal 2018, net cash provided by investing activities was $2.6 million compared to net cash used in investing activities of $171.0 million and $112.6 million in fiscal 2017 and 2016, respectively. In fiscal 2018, we paid $558.3 million to purchase 75% of the outstanding shares of Forestar, which had $401.9 million of cash on the acquisition date. In fiscal 2016, we paid $82.2 million to purchase the homebuilding operations of Wilson Parker Homes and paid an additional $4.1 million in fiscal 2017 and $2.8 million in fiscal 2018 to complete the purchase. We used $68.1 million, $102.7 million and $78.1 million in fiscal 2018, 2017 and 2016, respectively, to purchase and construct property and equipment, including model home furniture, office buildings and office and technology equipment to support our operations. Also, we used $70.2 million, $54.6 million and $8.0 million in fiscal 2018, 2017 and 2016, respectively, for the development and construction of multi-family rental properties.

Investing cash flows in fiscal 2018 included proceeds from the sale of assets of $292.9 million, of which $258.3 million related to Forestar, primarily from the strategic sale of assets. Additionally, proceeds of $24.8 million resulted from the sale of multi-family rental units constructed by our homebuilding operations in one community in our Southeast region.

Financing Cash Flow Activities

We expect the short-term financing needs of our operations will be funded with existing cash, cash generated from operations and borrowings under our credit facilities. Long-term financing needs for the growth of our homebuilding and Forestar operations may be funded with the issuance of senior unsecured debt securities or equity securities through the public capital markets.

In fiscal 2018, net cash used in financing activities was $82.5 million, consisting primarily of note repayments that were largely offset by note proceeds, payments of cash dividends and repurchases of common stock. Note repayments of $2.2 billion included the repayments of amounts drawn on our homebuilding revolving credit facility of $1.8 billion and our early redemption of the $400 million principal amount of our 3.625% senior notes due February 2018. Proceeds from notes payable of $2.2 billion included draws of $1.8 billion on our homebuilding revolving credit facility and our issuance of $400 million principal amount of 2.55% senior notes due December 1, 2020. Our financial services segment received proceeds of $217.7 million from net advances under its mortgage repurchase facility. During fiscal 2018, we used cash of $188.4 million to pay dividends to our common stockholders and $127.5 million to repurchase 2.8 million shares of our common stock.

In fiscal 2017, net cash used in financing activities was $564.6 million, consisting primarily of note repayments, payments of cash dividends and repurchases of common stock, partially offset by note proceeds. Note repayments of $1.2 billion included the repayment of $350 million principal amount of our 4.75% senior notes at maturity and repayments of amounts drawn on our homebuilding revolving credit facility of $835 million. Proceeds from notes payable of $835 million represent draws on our homebuilding revolving credit facility. During fiscal 2017, we used cash of $149.6 million to pay dividends to our common stockholders and $60.6 million to repurchase 1.9 million shares of our common stock. In fiscal 2016, net cash used in financing activities was $591.9 million, consisting primarily of note repayments and payments of cash dividends. Note repayments of $544.8 million included the repayment of $170.2 million principal amount of our 5.625% senior notes and $372.7 million principal amount of our 6.5% senior notes at maturity.

Our Board of Directors approved and paid quarterly cash dividends of $0.125 per common share, $0.10 per common share and $0.08 per common share in fiscal 2018, 2017 and 2016 respectively. In November 2018, our Board of Directors approved a cash dividend of $0.15 per common share, payable on December 10, 2018, to stockholders of record on November 26, 2018. The declaration of future cash dividends is at the discretion of our Board of Directors and will depend upon, among other things, our future earnings, cash flows, capital requirements, financial condition and general business conditions.

Contractual Cash Obligations, Commercial Commitments and Off-Balance Sheet Arrangements

Our primary contractual cash obligations are payments under our debt agreements and lease payments under operating leases. We expect to fund our contractual obligations in the ordinary course of business through a combination of our existing cash resources, cash flows generated from profits, our credit facilities or other bank financing, and the issuance of new debt or equity securities through the public capital markets as market conditions may permit.

Our future cash requirements for contractual obligations as of September 30, 2018 are presented below.

	Payments Due by Period
	Total				Less Than 1 Year				1 - 3 Years				> 3 - 5 Years				More Than 5 Years
	(In millions)
Notes Payable — Principal (1)	$	3,211.1			$	1,142.2			$	1,018.9			$	1,050.0			$	—
Notes Payable — Interest (1)	315.0				121.4				116.2				77.4				—
Operating Leases	42.3				16.8				18.8				5.9				0.8
Purchase Obligations (2)	47.4				22.2				25.2				—				—
	$	3,615.8			$	1,302.6			$	1,179.1			$	1,133.3			$	0.8

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(1)

Notes payable represents principal and interest payments due on our senior notes, our secured notes, our mortgage subsidiary’s repurchase facility and our homebuilding and Forestar revolving credit facilities. Because the balances of our revolving credit facilities were zero at September 30, 2018, we did not assume any principal or interest payments related to these facilities in future periods. The interest obligation associated with our mortgage repurchase facility is based on its annual effective rate of 4.1% and principal balance outstanding at September 30, 2018.

(2)

Purchase obligations relate to our land and lot option purchase contracts which enable us to control significant lot positions with limited capital investment. Among our land and lot option purchase contracts at September 30, 2018, there were a limited number of contracts, representing $47.4 million of remaining purchase price, subject to specific performance provisions which may require us to purchase the land or lots upon the land sellers meeting their contractual obligations.

At September 30, 2018, we had outstanding letters of credit of $128.5 million and surety bonds of $1.5 billion, issued by third parties to secure performance under various contracts. We expect that our performance obligations secured by these letters of credit and bonds will generally be completed in the ordinary course of business and in accordance with the applicable contractual terms. When we complete our performance obligations, the related letters of credit and bonds are generally released shortly thereafter, leaving us with no continuing obligations. We have no material third-party guarantees.

Our mortgage subsidiary enters into various commitments related to the lending activities of our mortgage operations. Further discussion of these commitments is provided in Item 7A “Quantitative and Qualitative Disclosures About Market Risk” under Part II of this annual report on Form 10-K.

Seasonality

Although significant changes in market conditions have impacted our seasonal patterns in the past and could do so again in the future, we generally close more homes and generate greater revenues and operating income in the third and fourth quarters of our fiscal year. The seasonal nature of our business can also cause significant variations in our working capital requirements in both our homebuilding and financial services operations. As a result of seasonal activity, our quarterly results of operations and financial position at the end of a particular fiscal quarter are not necessarily representative of the balance of our fiscal year.

Inflation

We may be adversely affected during periods of high inflation, primarily because of higher financing, land, labor and material construction costs. We attempt to offset cost increases in one component with savings in another, and we increase our sales prices and reduce customer sales incentives when housing market conditions permit. However, during periods when housing market conditions are challenging, we may not be able to offset cost increases with higher selling prices. In addition, higher mortgage interest rates reduce the affordability of our homes to prospective homebuyers.

Forward-Looking Statements

Some of the statements contained in this report, as well as in other materials we have filed or will file with the Securities and Exchange Commission, statements made by us in periodic press releases and oral statements we make to analysts, stockholders and the press in the course of presentations about us, may be construed as “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, Section 21E of the Securities Exchange Act of 1934 and the Private Securities Litigation Reform Act of 1995. Forward-looking statements are based on management’s beliefs as well as assumptions made by, and information currently available to, management. These forward-looking statements typically include the words “anticipate,” “believe,” “consider,” “estimate,” “expect,” “forecast,” “goal,” “intend,” “objective,” “plan,” “predict,” “projection,” “seek,” “strategy,” “target,” “will” or other words of similar meaning. Any or all of the forward-looking statements included in this report and in any other of our reports or public statements may not approximate actual experience, and the expectations derived from them may not be realized, due to risks, uncertainties and other factors. As a result, actual results may differ materially from the expectations or results we discuss in the forward-looking statements. These risks, uncertainties and other factors include, but are not limited to:

•	the cyclical nature of the homebuilding industry and changes in economic, real estate and other conditions;

•	constriction of the credit and public capital markets, which could limit our ability to access capital and increase our costs of capital;

•	reductions in the availability of mortgage financing provided by government agencies, changes in government financing programs, a decrease in our ability to sell mortgage loans on attractive terms or an increase in mortgage interest rates;

•	the risks associated with our land and lot inventory;

•	our ability to effect our growth strategies, acquisitions or investments successfully;

•	the impact of an inflationary, deflationary or higher interest rate environment;

•	home warranty and construction defect claims;

•	the effects of health and safety incidents;

•	the effects of negative publicity;

•	supply shortages and other risks of acquiring land, building materials and skilled labor;

•	reductions in the availability of performance bonds;

•	increases in the costs of owning a home;

•	the effects of governmental regulations and environmental matters on our homebuilding and land development operations;

•	the effects of governmental regulations on our financial services operations;

•	our significant debt and our ability to comply with related debt covenants, restrictions and limitations;

•	competitive conditions within the homebuilding and financial services industries;

•	the effects of the loss of key personnel; and

•	information technology failures and data security breaches.

We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. However, any further disclosures made on related subjects in subsequent reports on Forms 10-K, 10-Q and 8-K should be consulted. Additional information about issues that could lead to material changes in performance and risk factors that have the potential to affect us is contained in Item 1A, “Risk Factors” under Part I of this annual report on Form 10-K.

Critical Accounting Policies

General — A comprehensive enumeration of the significant accounting policies of D.R. Horton, Inc. and subsidiaries is presented in Note A to the accompanying financial statements as of September 30, 2018 and 2017, and for the years ended September 30, 2018, 2017 and 2016. Each of our accounting policies has been chosen based upon current authoritative literature that collectively comprises U.S. Generally Accepted Accounting Principles (GAAP). In instances where alternative methods of accounting are permissible under GAAP, we have chosen the method that most appropriately reflects the nature of our business, the results of our operations and our financial condition, and have consistently applied those methods over each of the periods presented in the financial statements. The Audit Committee of our Board of Directors has reviewed and approved the accounting policies selected.

Revenue Recognition — We generally recognize homebuilding revenue and related profit at the time of the closing of a sale, when title to and possession of the property are transferred to the buyer. In situations where the buyer’s financing is originated by DHI Mortgage, our 100% owned mortgage subsidiary, and the buyer has not made an adequate initial or continuing investment, the profit is deferred until the sale of the related mortgage loan to a third-party purchaser has been completed. Any profit on land sales is deferred until the full accrual method criteria are met. When appropriate, revenue and profit on long-term construction projects are recognized under the percentage-of-completion method.

We include proceeds from home closings held for our benefit at title companies in homebuilding cash. When we execute sales contracts with our homebuyers, or when we require advance payment from homebuyers for custom changes, upgrades or options related to their homes, we record the cash deposits received as liabilities until the homes are closed or the contracts are cancelled. We either retain or refund to the homebuyer deposits on cancelled sales contracts, depending upon the applicable provisions of the contract or other circumstances.

We recognize financial services revenues associated with our title operations as closing services are rendered and title insurance policies are issued, both of which generally occur simultaneously as each home is closed. We transfer substantially all underwriting risk associated with title insurance policies to third-party insurers. We typically elect the fair value option for our mortgage loan originations. Mortgage loans held for sale are initially recorded at fair value based on either sale commitments or current market quotes and are adjusted for subsequent changes in fair value until the loans are sold. Net origination costs and fees associated with mortgage loans are recognized at the time of origination. The expected net future cash flows related to the associated servicing of a loan are included in the measurement of all written loan commitments that are accounted for at fair value through earnings at the time of commitment. We sell substantially all of the mortgages we originate and the related servicing rights to third-party purchasers. Interest income is earned from the date a mortgage loan is originated until the loan is sold.

Some mortgage loans are sold with limited recourse provisions, which can result in repurchases of loans previously sold to investors or payments to reimburse investors for loan losses. Based on historical experience, discussions with our mortgage purchasers, analysis of the mortgages we originated and current housing and credit market conditions, we estimate and record a loss reserve for mortgage loans held in portfolio and mortgage loans held for sale, as well as known and projected mortgage loan repurchase requests.

Inventories and Cost of Sales — Inventory includes the costs of direct land acquisition, land development and home construction, capitalized interest, real estate taxes and direct overhead costs incurred during development and home construction. Costs that we incur after development projects or homes are substantially complete, such as utilities, maintenance, and cleaning, are charged to SG&A expense as incurred. All indirect overhead costs, such as compensation of sales personnel, division and region management, and the costs of advertising and builder’s risk insurance are charged to SG&A expense as incurred.

Land and development costs are typically allocated to individual residential lots on a pro-rata basis, and the costs of residential lots are transferred to construction in progress when home construction begins. Home construction costs are specifically identified and recorded to individual homes. Cost of sales for homes closed includes the specific construction costs of each home and all applicable land acquisition, land development and related costs (both incurred and estimated to be incurred) allocated to each residential lot based upon the total number of homes expected to be closed in each community. Any changes to the estimated total development costs subsequent to the initial home closings in a community are generally allocated on a pro-rata basis to the remaining homes in the community associated with the relevant development activity.

When a home is closed, we generally have not paid all incurred costs necessary to complete the home. We record a liability and a charge to cost of sales for the amount estimated to ultimately be paid related to completed homes that have been closed. We compare our home construction budgets to actual recorded costs to determine the additional costs remaining to be paid on each closed home. We monitor the accrual by comparing actual costs incurred on closed homes in subsequent months to the amounts previously accrued. Although actual costs to be paid in the future on previously closed homes could differ from our current accruals, such differences have not been significant.

Each quarter, we review our communities and land inventories for indicators of potential impairment. We generally review our inventory for impairment indicators at the community level, and the inventory within each community is categorized as land held for development, residential land and lots developed and under development, land held for sale and construction in progress and finished homes, based on the stage of production or plans for future development or sale. A particular community often includes inventory in more than one category. In certain situations, inventory may be analyzed separately for impairment purposes based on its product type or future plans. In reviewing each of our communities, we determine if impairment indicators exist on inventory held and used by analyzing a variety of factors including, but not limited to, the following:

•	gross margins on homes closed in recent months;

•	projected gross margins on homes sold but not closed;

•	projected gross margins based on community budgets;

•	trends in gross margins, average selling prices or cost of sales;

•	sales absorption rates; and

•	performance of other communities in nearby locations.

If indicators of impairment are present for a community, we perform an impairment evaluation of the community, which includes an analysis to determine if the undiscounted cash flows estimated to be generated by those assets are less than their carrying amounts. If so, impairment charges are recorded to cost of sales if the fair value of such assets is less than their carrying amounts. These estimates of cash flows are significantly impacted by community specific factors including estimates of the amounts and timing of future revenues and estimates of the amount of land development, materials and labor costs which, in turn, may be impacted by the following local market conditions:

•	supply and availability of new and existing homes;

•	location and desirability of our communities;

•	variety of product types offered in the area;

•	pricing and use of incentives by us and our competitors;

•	alternative uses for our land or communities such as the sale of land, finished lots or home sites to third parties;

•	amount of land and lots we own or control in a particular market or sub-market; and

•	local economic and demographic trends.

For those assets deemed to be impaired, the impairment to be recognized is measured as the amount by which the carrying amount of the assets exceeds the fair value of the assets. Our determination of fair value is primarily based on discounting the estimated cash flows at a rate commensurate with the inherent risks associated with the assets and related estimated cash flow streams. When an impairment charge for a community is determined, the charge is then allocated to each lot in the community in the same manner as land and development costs are allocated to each lot. Impairment charges are also recorded on finished homes in substantially completed communities when events or circumstances indicate that the carrying values are greater than the fair values less estimated costs to sell these homes.

For the inventory impairment analyses performed during fiscal 2018, we assumed that for the majority of communities, sales prices in future periods will be equal to or lower than current sales order prices in each community, or in comparable communities, in order to generate an acceptable absorption rate. The remaining lives of the communities evaluated were estimated to be in a range from one month to three years, and we utilized a range of discount rates for communities from 10% to 18%.

We rarely purchase land for resale. However, when we own land or communities under development that do not fit into our development and construction plans, and we determine that we will sell the asset, the project is accounted for as land held for sale if certain criteria are met. We record land held for sale at the lesser of its carrying value or fair value less estimated costs to sell. In performing the impairment evaluation for land held for sale, we consider several factors including, but not limited to, recent offers received to purchase the property, prices for land in recent comparable sales transactions and market analysis studies, which include the estimated price a willing buyer would pay for the land. If the estimated fair value less costs to sell an asset is less than the current carrying value, the asset is written down to its estimated fair value less costs to sell.

The key assumptions relating to inventory valuations are impacted by local market and economic conditions, and are inherently uncertain. Although our quarterly assessments reflect management’s best estimates, due to uncertainties in the estimation process, actual results could differ from such estimates.

Business Acquisitions — We account for acquisitions of businesses by allocating the purchase price of the business to the various assets acquired and liabilities assumed at their respective fair values. Any excess of the purchase price over the estimated fair values of the identifiable net assets acquired is recorded as goodwill. Significant judgment is often required in estimating the fair value of assets acquired, particularly intangible assets. These estimates and assumptions are based on historical experience, information obtained from the management of the acquired companies and our estimates of significant assumptions that a market participant would use when determining fair value. While we believe the estimates and assumptions are reasonable, they are inherently uncertain. Unanticipated market or macroeconomic events and circumstances may occur, which could affect the accuracy or validity of the estimates and assumptions.

Goodwill — We record goodwill associated with our acquisitions of businesses when the purchase price of the business exceeds the fair value of the net tangible and identifiable intangible assets acquired. We evaluate our goodwill balances for potential impairment on at least an annual basis by comparing the carrying value of each of our operating segments with goodwill to their estimated fair values. The estimated fair value is determined by discounting the future cash flows of the operating segment to their present value. If the carrying value of the operating segment exceeds its fair value, we determine if an impairment exists based on the implied fair value of the operating segment’s goodwill. As a result of the goodwill evaluations performed in fiscal 2018 and 2017, no impairment charges were recorded. As a result of the goodwill evaluation performed in fiscal 2016, an impairment charge of $7.2 million was recorded to write off the remaining goodwill associated with the Huntsville operating segment in the Southeast reporting region. This operating segment experienced lower levels of profitability than anticipated primarily due to difficult market conditions. Our total goodwill balance was $109.2 million and $80.0 million at September 30, 2018 and 2017, respectively.

Warranty Claims — We typically provide our homebuyers with a ten-year limited warranty for major defects in structural elements such as framing components and foundation systems, a two-year limited warranty on major mechanical systems and a one-year limited warranty on other construction components. Since we subcontract our construction work to subcontractors who typically provide us with an indemnity and a certificate of insurance prior to receiving payments for their work, claims relating to workmanship and materials are generally the primary responsibility of the subcontractors. Warranty liabilities have been established by charging cost of sales for each home delivered. The amounts charged are based on management’s estimate of expected warranty-related costs under all unexpired warranty obligation periods. Our warranty liability is based upon historical warranty cost experience in each market in which we operate and is adjusted to reflect qualitative risks associated with the types of homes we build and the geographic areas in which we build them. Actual future warranty costs could differ from our currently estimated amounts. A 10% change in the historical warranty rates used to estimate our warranty accrual would not result in a material change in our accrual.

Legal Claims and Insurance — We are named as a defendant in various claims, complaints and other legal actions in the ordinary course of business. At any point in time, we are managing several hundred individual claims related to construction defect matters, personal injury claims, employment matters, land development issues, contract disputes and other matters. We have established reserves for these contingencies based on the estimated costs of pending claims and the estimated costs of anticipated future claims related to previously closed homes. Approximately 99% and 98% of these reserves related to construction defect matters at September 30, 2018 and 2017, respectively.

Our reserves for construction defect claims include the estimated costs of both known claims and anticipated future claims. At September 30, 2018 and 2017, we had reserves for approximately 155 and 140 pending construction defect claims, respectively, and no individual existing claim was material to our financial statements. During fiscal 2018, we established reserves for approximately 95 new construction defect claims and resolved 80 construction defect claims for a total cost of $40.0 million. We have closed a significant number of homes during recent years, and we may be subject to future construction defect claims on these homes. Although regulations vary from state to state, construction defect issues can generally be reported for up to ten years after the home has closed in many states in which we operate. Historical data and trends regarding the frequency of claims incurred and the costs to resolve claims relative to the types of products and markets where we operate are used to estimate the construction defect liabilities for both existing and anticipated future claims. These estimates are subject to ongoing revision as the circumstances of individual pending claims and historical data and trends change. Adjustments to estimated reserves are recorded in the accounting period in which the change in estimate occurs.

Historical trends in construction defect claims have been inconsistent, and we believe they may continue to fluctuate. Housing market conditions have been volatile across most of our markets over the past ten years, and we believe such conditions can affect the frequency and cost of construction defect claims. If the ultimate resolution of construction defect claims resulting from our home closings in prior years varies from current expectations, it could significantly change our estimates regarding the frequency and timing of claims incurred and the costs to resolve existing and anticipated future claims, which would impact the construction defect reserves in the future. If the frequency of claims incurred or costs of existing and future legal claims significantly exceed our current estimates, they will have a significant negative impact on our future earnings and liquidity.

We estimate and record receivables under the applicable insurance policies related to our estimated contingencies for known claims and anticipated future construction defect claims on previously closed homes and other legal claims and lawsuits incurred in the ordinary course of business when recovery is probable. Additionally, we may have the ability to recover a portion of our losses from our subcontractors and their insurance carriers when we have been named as an additional insured on their insurance policies.

The estimation of losses related to these reserves and the related estimates of recoveries from insurance policies are subject to a high degree of variability due to uncertainties such as trends in construction defect claims relative to our markets and the types of products built, claim frequency, claim settlement costs and patterns, insurance industry practices and legal interpretations, among others. Due to the high degree of judgment required in establishing reserves for these contingencies, actual future costs and recoveries from insurance could differ significantly from current estimated amounts. A 10% increase in the claim frequency and the average cost per claim used to estimate the reserves would result in an increase of approximately $67.2 million in our reserves and a $30.4 million increase in our receivable, resulting in additional expense of $36.8 million. A 10% decrease in the claim frequency and the average cost per claim would result in a decrease of approximately $60.4 million in our reserves and a $22.7 million decrease in our receivable, resulting in a reduction in expense of $37.7 million.

Income Taxes — We calculate our income tax expense using the asset and liability method, under which deferred tax assets and liabilities are recognized based on the future tax consequences attributable to temporary differences between the financial statement amounts of assets and liabilities and their respective tax bases and attributable to net operating losses and tax credit carryforwards. When assessing the realizability of deferred tax assets, we consider whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The realization of deferred tax assets is dependent upon the generation of sufficient taxable income in future periods and in the jurisdictions in which those temporary differences become deductible. We record a valuation allowance when we determine it is more likely than not that a portion of our deferred tax assets will not be realized. The accounting for deferred taxes is based upon estimates of future results. Differences between the anticipated and actual outcomes of these future results could have a material impact on our consolidated results of operations or financial position. Also, changes in existing federal and state tax laws and tax rates could affect future tax results and the valuation of our deferred tax assets.

Interest and penalties related to unrecognized tax benefits are recognized in the financial statements as a component of income tax expense. Significant judgment is required to evaluate uncertain tax positions. We evaluate our uncertain tax positions on a quarterly basis. Our evaluations are based upon a number of factors, including changes in facts or circumstances, changes in tax law, correspondence with tax authorities during the course of audits and effective settlement of audit issues. Changes in the recognition or measurement of uncertain tax positions could result in increases or decreases in our income tax expense in the period in which we make the change.

Stock-Based Compensation — Our stockholders formally authorize shares of our common stock to be available for future grants of stock-based compensation awards. From time to time, the Compensation Committee of our Board of Directors authorizes the grant of stock-based compensation to our employees and directors from these available shares. At September 30, 2018, our outstanding stock-based compensation awards include stock options and restricted stock units. Grants of restricted stock units may vest immediately or over a certain number of years as determined by the Compensation Committee of our Board of Directors. Restricted stock units outstanding at September 30, 2018 have a remaining vesting period of 1 to 5 years. Stock options are granted at exercise prices which equal the market value of our common stock at the date of the grant. The stock options outstanding at September 30, 2018 vest during fiscal 2019 and expire 10 years after the dates on which they were granted.

The compensation expense for stock-based awards is based on the fair value of the award and is recognized on a straight-line basis over the remaining vesting period. The fair values of restricted stock units are based on our stock price at the date of grant. The fair values of stock options granted are calculated on the date of grant using a Black-Scholes option pricing model. Determining the fair value of stock options requires judgment in developing assumptions and involves a number of estimates. These estimates include, but are not limited to, the expected stock price volatility over the term of the awards, the expected dividend yield and expected stock option exercise behavior. In addition, we also use judgment in estimating the number of stock options that are expected to be forfeited.

Fair Value Measurements — The Financial Accounting Standards Board’s (FASB) authoritative guidance for fair value measurements establishes a three-level hierarchy based upon the inputs to the valuation model of an asset or liability. The fair value hierarchy and its application to our assets and liabilities, is as follows:

•	Level 1 — Valuation is based on quoted prices in active markets for identical assets and liabilities.

•	Level 2 — Valuation is determined from quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar instruments in markets that are not active, or by model-based techniques in which all significant inputs are observable in the market.

•	Level 3 — Valuation is typically derived from model-based techniques in which at least one significant input is unobservable and based on our own estimates about the assumptions that market participants would use to value the asset or liability.

When available, we use quoted market prices in active markets to determine fair value. We consider the principal market and nonperformance risk associated with our counterparties when determining the fair value measurements, if applicable. Fair value measurements are used for our mortgage loans held for sale, debt securities collateralized by residential real estate, interest rate lock commitments (IRLCs) and other derivative instruments on a recurring basis and are used for inventories, other mortgage loans and real estate owned on a nonrecurring basis, when events and circumstances indicate that the carrying value may not be recoverable.

Recent Accounting Pronouncements

In May 2014, the FASB issued ASU 2014-09, “Revenue from Contracts with Customers,” which is a comprehensive new revenue recognition model that will replace most existing revenue recognition guidance. The core principle of this guidance is that an entity should recognize revenue for the transfer of goods or services equal to the amount that it expects to be entitled to receive for those goods or services. The guidance is effective for us beginning October 1, 2018 and allows for full retrospective or modified retrospective methods of adoption. We plan to adopt this standard using the modified retrospective method. Upon adoption of the standard, we expect to record an adjustment to increase retained earnings and recognize a contract asset for expected future insurance brokerage commission renewals. We have not yet determined the amount of this adjustment and are continuing to evaluate other effects of the standard, but we do not expect the adoption of this standard to have a material impact on our consolidated financial position, results of operations or cash flows.

In January 2016, the FASB issued ASU 2016-01, “Financial Instruments - Recognition and Measurement of Financial Assets and Financial Liabilities,” which addresses certain aspects of recognition, measurement, presentation and disclosure of financial instruments. The guidance is effective for us beginning October 1, 2018 and is not expected to have a material impact on our consolidated financial position, results of operations or cash flows.

In February 2016, the FASB issued ASU 2016-02, “Leases,” which requires that lease assets and liabilities be recognized on the balance sheet and that key information about leasing arrangements be disclosed. The guidance is effective for us beginning October 1, 2019, although early adoption is permitted. We are currently evaluating the impact of this guidance on our consolidated financial position, results of operations and cash flows.

In June 2016, the FASB issued ASU 2016-13, “Financial Instruments - Credit Losses,” which replaces the current incurred loss impairment methodology with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information in determining credit loss estimates. The guidance is effective for us beginning October 1, 2020 and is not expected to have a material impact on our consolidated financial position, results of operations or cash flows.

In August 2016, the FASB issued ASU 2016-15, “Statement of Cash Flows - Classification of Certain Cash Receipts and Cash Payments,” which amends and clarifies the current guidance to reduce diversity in practice of the classification of certain cash receipts and payments in the statement of cash flows. The guidance is effective for us beginning October 1, 2018 and is not expected to have a material impact on our consolidated statements of cash flows.

In October 2016, the FASB issued ASU 2016-16, “Income Taxes - Intra-Entity Transfers of Assets Other Than Inventory,” which requires companies to recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs. The guidance is effective for us beginning October 1, 2018 and is not expected to have a material impact on our consolidated financial position or cash flows.

In November 2016, the FASB issued ASU 2016-18, “Statement of Cash Flows - Restricted Cash,” which requires amounts generally described as restricted cash and restricted cash equivalents be included with cash and cash equivalents when reconciling the total beginning and ending amounts for the periods shown on the statement of cash flows. The guidance is effective for us beginning October 1, 2018 and is not expected to have a material impact on our consolidated financial position or cash flows.

In January 2017, the FASB issued ASU 2017-04, “Intangibles - Goodwill and Other,” which simplifies the measurement of goodwill impairment by removing the second step of the goodwill impairment test and requires the determination of the fair value of individual assets and liabilities of a reporting unit. Under the new guidance, goodwill impairment is measured as the amount by which a reporting unit’s carrying amount exceeds its fair value with the loss recognized limited to the total amount of goodwill allocated to the reporting unit. The guidance is effective for us beginning October 1, 2020 and is not expected to have a material impact on our consolidated financial position, results of operations or cash flows.

In February 2017, the FASB issued ASU 2017-05, “Other Income - Gains and Losses from the Derecognition of Nonfinancial Assets,” which updates the definition of an in substance nonfinancial asset and clarifies the derecognition guidance for nonfinancial assets to conform to the new revenue recognition standard (ASU 2014-09). The guidance is effective for us beginning October 1, 2018, concurrent with the adoption of ASU 2014-09, as required, and is not expected to have a material impact on our consolidated financial position, results of operations or cash flows.

In May 2017, the FASB issued ASU 2017-09, “Compensation - Stock Compensation: Scope of Modification Accounting,” which clarifies which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting. Under the new guidance, modification accounting is required if the fair value, vesting conditions or classification (equity or liability) of the new award are different from the original award immediately before the original award is modified. The guidance is effective for us beginning October 1, 2018 and is not expected to have a material impact on our consolidated financial position, results of operations or cash flows.