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

Results of Operations — Fiscal Year 2019 Overview

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 resulted in some moderation of demand for new homes across most of our markets in late fiscal 2018 and early fiscal 2019, and in response, we increased our sales incentives to improve sales pace. Later in fiscal 2019, interest rates on mortgage loans decreased, and we reduced sales incentives as demand strengthened compared to earlier in the year. We continue to see solid economic fundamentals and a limited supply of homes at affordable prices across most of our markets.

We believe our business is well positioned with a broad geographic footprint, affordable product offerings, a balanced supply of finished lots, land and homes, a strong balance sheet and liquidity position and experienced personnel across our operating markets. We remain focused on growing our revenues and profitability, generating consistently strong 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 2019, our number of homes closed and home sales revenues increased 10% and 9%, respectively, compared to the prior year. Our pre-tax income was $2.1 billion in both fiscal 2019 and 2018. Our pre-tax operating margin was 12.1% in fiscal 2019 compared to 12.8% in fiscal 2018. Cash provided by our homebuilding operations was $1.4 billion in fiscal 2019 compared to $1.0 billion in fiscal 2018. In fiscal 2019, our homebuilding return on inventory (ROI) was 18.1% compared to 20.2% in fiscal 2018. 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 purchase contracts represent 60% of the lots owned and controlled at September 30, 2019 compared to 57% at September 30, 2018. Growing our majority-owned Forestar lot development operations is advancing our homebuilding strategy of increasing our controlled finished lot pipeline.

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 vary across our markets. If the U.S. economy continues to grow, we expect to see solid 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, increases in mortgage interest rates or tightening of mortgage lending standards.

Strategy

Our operating strategy focuses on enhancing long-term value to our shareholders by leveraging our financial and competitive position in our core homebuilding business 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:

•	Developing and retaining highly experienced and productive teams of personnel throughout our company that are aligned and focused on continuous improvement in our operational execution and financial performance.

•	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 and a positive experience to our customers 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 purchase contracts by expanding relationships with land developers across the country and continuing to assist our majority-owned Forestar lot development subsidiary with the growth of their operations.

•	Opportunistically pursuing acquisitions to enhance our operations and improve returns.

•	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.

•	Ensuring that our financial services business provides high quality mortgage and title services to homebuyers efficiently and effectively.

•	Investing in the construction of garden style multi-family rental properties to meet rental demand in high growth suburban markets, and selling these properties profitably.

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, 2019, as compared to fiscal 2018 (or from the acquisition date of October 5, 2017 through September 30, 2018 for Forestar’s results), were as follows:

Homebuilding:

•	Homebuilding revenues increased 9% to $17.0 billion compared to $15.6 billion.

•	Homes closed increased 10% to 56,975 homes, and the average closing price of those homes was $297,100.

•	Net sales orders increased 7% to 56,565 homes, and the value of net sales orders increased 7% to $16.8 billion.

•	Sales order backlog increased 2% to 13,613 homes, and the value of sales order backlog increased 3% to $4.1 billion.

•	Home sales gross margin was 20.2% compared to 21.3%.

•	Homebuilding SG&A expense was 8.7% of homebuilding revenues compared to 8.6%.

•	Homebuilding pre-tax income was $1.9 billion compared to $2.0 billion.

•	Homebuilding pre-tax income was 11.2% of homebuilding revenues compared to 12.5%.

•	Homebuilding return on inventory was 18.1% compared to 20.2%.

•	Net cash provided by homebuilding operations was $1.4 billion compared to $1.0 billion.

•	Homebuilding cash and cash equivalents totaled $1.0 billion compared to $1.1 billion.

•	Homebuilding inventories totaled $10.3 billion compared to $9.9 billion.

•	Homes in inventory totaled 27,700 compared to 27,900.

•	Owned lots totaled 121,400 compared to 124,300, and lots controlled through purchase contracts increased to 185,900 from 164,200.

•	Homebuilding debt decreased to $2.0 billion from $2.4 billion.

•	Homebuilding debt to total capital improved to 17.0% compared to 21.4%.

Forestar:

•	Forestar’s revenues increased 292% to $428.3 million compared to $109.2 million. Revenues in fiscal 2019 and 2018 included $326.6 million and $39.1 million, respectively, of revenue from land and lot sales to our homebuilding segment.

•	Forestar’s lot sales increased 223% to 4,132 compared to 1,279. Lot sales to D.R. Horton were 3,728 compared to 642.

•	Forestar’s pre-tax income was $45.7 million compared to $48.7 million.

•	Forestar’s pre-tax income was 10.7% of Forestar revenues compared to 44.6%.

•	Forestar’s cash and cash equivalents totaled $382.8 million compared to $318.8 million.

•	Forestar’s inventories totaled $1.0 billion compared to $498.0 million.

•	Owned and controlled lots totaled 38,300 compared to 20,100. Of these lots, 23,400 were under contract to sell to or subject to a right of first offer with D.R. Horton compared to 13,600.

•	Forestar’s debt was $460.5 million compared to $111.7 million.

Financial Services:

•	Financial services revenues increased 18% to $441.7 million compared to $375.3 million.

•	Financial services pre-tax income increased 41% to $166.3 million compared to $117.8 million.

•	Financial services pre-tax income was 37.6% of financial services revenues compared to 31.4%.

Consolidated Results:

•	Consolidated pre-tax income increased 3% to $2.1 billion.

•	Consolidated pre-tax income was 12.1% of consolidated revenues compared to 12.8%.

•	Income tax expense was $506.7 million compared to $597.7 million.

•	Net income attributable to D.R. Horton increased 11% to $1.6 billion compared to $1.5 billion.

•	Diluted net income per common share attributable to D.R. Horton increased 13% to $4.29 compared to $3.81.

•	Net cash provided by operations was $892.1 million compared to $545.2 million.

•	Stockholders’ equity was $10.0 billion compared to $9.0 billion.

•	Book value per common share increased 14% to $27.20 compared to $23.88.

•	Debt to total capital improved to 25.3% compared to 26.3%.

Results of Operations — Homebuilding

Our operating segments are our 52 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, Iowa, Minnesota and Ohio
	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, 2019 and 2018. For similar operating and financial data and discussion of our fiscal 2018 results compared to our fiscal 2017 results, refer to Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” under Part II of our annual report on Form 10-K for the fiscal year ended September 30, 2018, which was filed with the SEC on November 16, 2018.

		Net Sales Orders (1)
		Fiscal Year Ended September 30,
		Net Homes Sold							Value (In millions)											Average Selling Price
		2019		2018		% Change			2019				2018				% Change			2019				2018				% Change
East		7,941		6,994		14	%		$	2,291.1			$	1,988.8			15	%		$	288,500			$	284,400			1	%
Midwest		3,224		2,209		46	%		1,127.8				864.3				30	%		349,800				391,300				(11	)%
Southeast		18,609		17,380		7	%		5,011.2				4,640.7				8	%		269,300				267,000				1	%
South Central		16,278		15,317		6	%		4,123.5				3,849.8				7	%		253,300				251,300				1	%
Southwest		2,797		3,179		(12	)%		750.6				784.4				(4	)%		268,400				246,700				9	%
West		7,716		7,661		1	%		3,539.2				3,632.7				(3	)%		458,700				474,200				(3	)%
		56,565		52,740		7	%		$	16,843.4			$	15,760.7			7	%		$	297,800			$	298,800			—	%

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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)
		2019		2018		2019				2018				2019			2018
East		2,155		2,031		$	607.3			$	570.0			21	%		23	%
Midwest		680		299		229.2				115.1				17	%		12	%
Southeast		5,410		5,655		1,444.4				1,502.5				23	%		25	%
South Central		4,751		4,408		1,193.2				1,091.9				23	%		22	%
Southwest		969		1,031		247.0				251.8				26	%		24	%
West		1,323		1,378		614.0				661.3				15	%		15	%
		15,288		14,802		$	4,335.1			$	4,192.6			21	%		22	%

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

Net Sales Orders

The number of net sales orders increased 7% during 2019 compared to 2018, with increases in most of our regions. The value of net sales orders increased 7% to $16.8 billion (56,565 homes) in 2019 from $15.8 billion (52,740 homes) in 2018. The average selling price of homes sold during fiscal 2019 was $297,800, essentially unchanged from the prior year.

Higher sales volumes in our East and Midwest regions reflect our acquisitions of the homebuilding operations of Terramor Homes, Westport Homes and Classic Builders in early fiscal 2019, which added 262 net sales orders to the East region’s results and 1,199 net sales orders to the Midwest region's results. Lower sales volume in our Southwest region during 2019 was due to a decrease in sales orders in our Phoenix market. Our sales order cancellation rate (cancelled sales orders divided by gross sales orders for the period) was 21% in 2019 compared to 22% in 2018.

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.

		Sales Order Backlog
		As of September 30,
		Homes in Backlog							Value (In millions)											Average Selling Price
		2019		2018		% Change			2019				2018				% Change			2019				2018				% Change
East		1,916		1,841		4	%		$	576.1			$	548.6			5	%		$	300,700			$	298,000			1	%
Midwest		1,063		442		140	%		364.7				179.2				104	%		343,100				405,400				(15	)%
Southeast		4,277		4,221		1	%		1,219.5				1,172.3				4	%		285,100				277,700				3	%
South Central		4,166		4,492		(7	)%		1,084.0				1,151.8				(6	)%		260,200				256,400				1	%
Southwest		815		928		(12	)%		241.6				251.7				(4	)%		296,400				271,200				9	%
West		1,376		1,447		(5	)%		654.2				725.3				(10	)%		475,400				501,200				(5	)%
		13,613		13,371		2	%		$	4,140.1			$	4,028.9			3	%		$	304,100			$	301,300			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.

		Homes Closed and Home Sales Revenue
		Fiscal Year Ended September 30,
		Homes Closed							Value (In millions)											Average Selling Price
		2019		2018		% Change			2019				2018				% Change			2019				2018				% Change
East		7,928		6,697		18	%		$	2,285.0			$	1,893.0			21	%		$	288,200			$	282,700			2	%
Midwest		3,193		2,186		46	%		1,113.8				857.5				30	%		348,800				392,300				(11	)%
Southeast		18,553		17,216		8	%		4,964.0				4,573.3				9	%		267,600				265,600				1	%
South Central		16,604		14,940		11	%		4,191.3				3,760.4				11	%		252,400				251,700				—	%
Southwest		2,910		3,094		(6	)%		760.6				725.4				5	%		261,400				234,500				11	%
West		7,787		7,724		1	%		3,610.3				3,692.4				(2	)%		463,600				478,000				(3	)%
		56,975		51,857		10	%		$	16,925.0			$	15,502.0			9	%		$	297,100			$	298,900			(1	)%

Home Sales Revenue

Revenues from home sales increased 9% to $16.9 billion (56,975 homes closed) in 2019 from $15.5 billion (51,857 homes closed) in 2018. Home sales revenues increased in most of our regions primarily due to an increase in the number of homes closed.

The number of homes closed in fiscal 2019 increased 10% from 2018. The increases in our East and Midwest regions reflect our acquisitions of the homebuilding operations of Terramor Homes, Westport Homes and Classic Builders in early fiscal 2019, which added 266 closings to the East region’s results and 1,157 closings to the Midwest region's results. Lower home closings volume in our Southwest region during 2019 was due to a decrease in closings in our Phoenix market. The average selling price of homes closed during fiscal 2019 was $297,100, down slightly from the prior year. Decreases in the average selling price of homes closed in the Midwest and West regions were largely offset by an increase in the average selling price in the Southwest region.

Homebuilding Operating Margin Analysis

		Percentages of Related Revenues
		Fiscal Year Ended September 30,
		2019			2018
Gross profit — home sales		20.2	%		21.3	%
Gross profit — land/lot sales and other		18.3	%		18.6	%
Inventory and land option charges		(0.3	)%		(0.3	)%
Gross profit — total homebuilding		19.9	%		21.0	%
Selling, general and administrative expense		8.7	%		8.6	%
Gain on sale of assets		—	%		(0.1	)%
Other (income)		(0.1	)%		—	%
Homebuilding pre-tax income		11.2	%		12.5	%

Home Sales Gross Profit

Gross profit from home sales increased 4% to $3.4 billion in 2019 from $3.3 billion in 2018 and decreased 110 basis points to 20.2% as a percentage of home sales revenues. The percentage decrease resulted from decreases of 130 basis points due to the average selling price of our homes closed decreasing while the average cost increased and 10 basis points from an increase in the amount of purchase accounting adjustments for recent acquisitions, partially offset by improvements of 20 basis points due to a reduction in warranty and construction defect expenses and 10 basis points due to 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.

Land/Lot Sales and Other Revenues

Land sales and other revenues from our homebuilding operations were $91.9 million and $121.8 million in fiscal 2019 and 2018, respectively. 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, 2019, our homebuilding operations had $19.8 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 2019, 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, 2019, we performed detailed impairment evaluations of communities and land inventories with a combined carrying value of $55.0 million and recorded impairment charges of $6.3 million during the fourth quarter to reduce the carrying value of impaired communities to fair value. Total homebuilding impairment charges during fiscal 2019 and 2018 were $24.9 million and $10.9 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 2019 and 2018, earnest money and pre-acquisition cost write-offs related to land purchase contracts that we have terminated or expect to terminate were $28.3 million and $13.4 million, respectively. Total inventory and land option charges for fiscal 2018 also included a charge of $24.5 million 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 increased 10% to $1.5 billion in fiscal 2019 from $1.3 billion in fiscal 2018. SG&A expense as a percentage of homebuilding revenues was 8.7% and 8.6% in fiscal 2019 and 2018, respectively.

Employee compensation and related costs represented 72% of SG&A costs in both fiscal 2019 and 2018. These costs increased 11% to $1.1 billion in 2019 from $964.2 million in 2018 due to an increase in the number of employees as compared to the prior year. Our homebuilding operations employed 6,810 and 6,419 employees at September 30, 2019 and 2018, 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 5% to $104.7 million in fiscal 2019 from $109.9 million in fiscal 2018. The decrease was due to a decrease in our average homebuilding debt in fiscal 2019 compared to the prior year. Interest charged to cost of sales was 0.9% and 1.1% of total cost of sales (excluding inventory and land option charges) in fiscal 2019 and 2018, respectively.

Gain on Sale of Assets

Gain on sale of assets from our homebuilding operations was $2.0 million in fiscal 2019 compared to $15.8 million in fiscal 2018. The higher gain on sale during the prior year primarily resulted from the sale of rental units in our homebuilding segment’s Southeast region.

Other Income

Other income, net of other expenses, included in our homebuilding operations was $9.5 million in fiscal 2019 compared to $7.2 million in fiscal 2018. 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 are not significant, either individually or in the aggregate.

Business Acquisitions

During fiscal 2019, we acquired the homebuilding operations of Westport Homes, Classic Builders and Terramor Homes for $325.9 million. The assets acquired included approximately 700 homes in inventory, 4,500 lots and control of approximately 4,300 additional lots through land purchase contracts. We also acquired a sales order backlog of approximately 700 homes. Westport Homes operates in Indianapolis and Fort Wayne, Indiana, and Columbus, Ohio; Classic Builders operates in Des Moines, Iowa; and Terramor Homes operates in Raleigh, North Carolina.

Homebuilding Results by Reporting Region

		Fiscal Year Ended September 30,
		2019											2018
		Homebuilding Revenues				Homebuilding Pre-tax Income (1)				% of Revenues			Homebuilding Revenues				Homebuilding Pre-tax Income (1)				% of Revenues
		(In millions)
East		$	2,290.2			$	238.8			10.4	%		$	1,893.4			$	217.3			11.5	%
Midwest		1,123.1				57.7				5.1	%		858.9				77.5				9.0	%
Southeast		4,977.8				584.7				11.7	%		4,578.6				536.0				11.7	%
South Central		4,202.4				551.1				13.1	%		3,769.9				506.1				13.4	%
Southwest		772.6				100.4				13.0	%		768.7				97.4				12.7	%
West		3,650.8				378.0				10.4	%		3,754.3				522.9				13.9	%
		$	17,016.9			$	1,910.7			11.2	%		$	15,623.8			$	1,957.2			12.5	%

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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.

East Region — Homebuilding revenues increased 21% in fiscal 2019 compared to fiscal 2018, primarily due to an increase in the number of homes closed in our Carolina markets. The acquisition of Terramor Homes in early fiscal 2019 contributed $85.0 million of revenues in the current year. The region generated pre-tax income of $238.8 million in 2019 compared to $217.3 million in 2018. Gross profit from home sales as a percentage of home sales revenue (home sales gross profit percentage) decreased by 130 basis points in 2019 compared to 2018, 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 2019 compared to 2018.

Midwest Region — Homebuilding revenues increased 31% in fiscal 2019 compared to fiscal 2018. The acquisitions of Westport Homes and Classic Builders in early fiscal 2019 contributed $328.8 million of revenues in the current year. The region generated pre-tax income of $57.7 million in 2019 compared to $77.5 million in 2018. Home sales gross profit percentage decreased by 360 basis points in 2019 compared to 2018, largely due to purchase accounting adjustments related to the two acquisitions. As a percentage of homebuilding revenues, SG&A expenses increased by 80 basis points in 2019 compared to 2018, primarily due to the increases in employee compensation and other costs associated with the two acquisitions.

Southeast Region — Homebuilding revenues increased 9% in fiscal 2019 compared to fiscal 2018, primarily due to an increase in the number of homes closed in our Florida markets. The region generated pre-tax income of $584.7 million in 2019 compared to $536.0 million in 2018. 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 decreased by 10 basis points in 2019 compared to 2018. As a percentage of homebuilding revenues, SG&A expenses increased by 10 basis points in 2019 compared to 2018.

South Central Region — Homebuilding revenues increased 11% in fiscal 2019 compared to fiscal 2018, primarily due to an increase in the number of homes closed in our Houston and Fort Worth markets. The region generated pre-tax income of $551.1 million in 2019 compared to $506.1 million in 2018. Home sales gross profit percentage decreased by 50 basis points in 2019 compared to 2018, 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 2019 compared to 2018.

Southwest Region — Homebuilding revenues increased 1% in fiscal 2019 compared to fiscal 2018. The region generated pre-tax income of $100.4 million in 2019 compared to $97.4 million in 2018. Home sales gross profit percentage increased by 130 basis points in 2019 compared to 2018, primarily due to the average selling price of homes closed increasing by more than the average cost of those homes. The gross profit percentage was also positively impacted by a decrease in warranty and construction defect costs. 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 increased by 20 basis points in 2019 compared to 2018.

West Region — Homebuilding revenues decreased 3% in fiscal 2019 compared to fiscal 2018, due to a decrease in the average selling price of homes closed. The region generated pre-tax income of $378.0 million in 2019 compared to $522.9 million in 2018. Home sales gross profit percentage decreased by 270 basis points in 2019 compared to 2018, primarily due to the average selling price decreasing while the average cost of those homes increased slightly. As a percentage of homebuilding revenues, SG&A expenses increased by 50 basis points in 2019 compared to 2018.

Homebuilding Inventories, Land and Lot Position and Homes in Inventory

We routinely enter into contracts to purchase land or developed residential lots at predetermined prices on a defined schedule commensurate with planned development or anticipated new home demand. At the time of purchase, the undeveloped land is generally 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, 2019 and 2018 are summarized as follows:

	September 30, 2019
	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	$	697.1			$	581.2			$	10.5			$	—			$	1,288.8
Midwest	473.9				361.1				1.8				—				836.8
Southeast	1,434.7				1,299.9				31.8				1.6				2,768.0
South Central	1,215.4				1,317.5				0.3				—				2,533.2
Southwest	221.8				335.6				1.6				15.4				574.4
West	1,089.0				950.6				13.9				2.5				2,056.0
Corporate and unallocated (1)	117.1				110.2				0.8				0.3				228.4
	$	5,249.0			$	4,956.1			$	60.7			$	19.8			$	10,285.6

	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

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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, 2019 and 2018 are summarized as follows:

	September 30, 2019
	Land/Lots Owned (1)			Lots Controlled Under Land and Lot Purchase Contracts (2)(3)			Total Land/Lots Owned and Controlled			Homes in Inventory (4)
East	11,000			30,500			41,500			3,900
Midwest	8,300			10,900			19,200			2,200
Southeast	34,800			73,300			108,100			8,900
South Central	41,600			51,400			93,000			7,900
Southwest	6,700			5,800			12,500			1,300
West	19,000			14,000			33,000			3,500
	121,400			185,900			307,300			27,700
	40	%		60	%		100	%

	September 30, 2018
	Land/Lots Owned (1)			Lots Controlled Under Land and Lot Purchase Contracts (2)(3)			Total Land/Lots Owned and Controlled			Homes in Inventory (4)
East	11,900			19,400			31,300			3,700
Midwest	3,800			9,300			13,100			1,700
Southeast	37,100			70,400			107,500			8,900
South Central	42,900			45,700			88,600			8,400
Southwest	7,600			5,000			12,600			1,400
West	21,000			14,400			35,400			3,800
	124,300			164,200			288,500			27,900
	43	%		57	%		100	%

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(1)	Land/lots owned include approximately 36,100 and 35,100 owned lots that are fully developed and ready for home construction at September 30, 2019 and 2018, respectively. Land/lots owned also include land held for development representing 1,700 lots at both September 30, 2019 and 2018.

(2)

The total remaining purchase price of lots controlled through land and lot purchase contracts at September 30, 2019 and 2018 was $7.2 billion and $6.5 billion, respectively, secured by earnest money deposits of $515.4 million and $401.1 million, respectively. The total remaining purchase price of lots controlled through land and lot purchase contracts at September 30, 2019 and 2018 included $953.8 million and $522.2 million, respectively, related to lot purchase contracts with Forestar, secured by $88.7 million and $48.0 million, respectively, of earnest money.

(3)

Lots controlled at September 30, 2019 include approximately 23,400 lots owned or controlled by Forestar, 12,800 of which our homebuilding divisions have under contract to purchase and 10,600 of which our homebuilding divisions have a right of first offer to purchase. Of these, approximately 8,700 lots were in our Southeast region, 4,600 lots were in our South Central region, 3,800 lots were in our West region, 2,600 lots were in our East region, 2,400 lots were in our Southwest region and 1,300 lots were in our Midwest region. Lots controlled at September 30, 2018 included approximately 13,600 lots owned or controlled by Forestar, 5,500 of which our homebuilding divisions had under contract to purchase and 8,100 of which our homebuilding divisions had a right of first offer to purchase.

(4)

Approximately 16,000 and 16,400 of our homes in inventory were unsold at September 30, 2019 and 2018, respectively. At September 30, 2019, approximately 5,200 of our unsold homes were completed, of which approximately 800 homes had been completed for more than six months. 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. Homes in inventory exclude approximately 1,900 and 1,800 model homes at September 30, 2019 and 2018, respectively.

Results of Operations — Forestar

On October 5, 2017, we acquired 75% of the outstanding shares of Forestar and as of September 30, 2019 owned approximately 66% of its outstanding shares. Forestar is a publicly traded residential lot development company with operations in 51 markets and 20 states as of September 30, 2019. 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 for fiscal 2019 and from the date of acquisition through September 30, 2018 (referred to as fiscal 2018 in the discussion below) were as follows:

		Year Ended September 30, 2019				For the Period from October 5, 2017 to September 30, 2018
		(In millions)
Residential land and lot sales		$	407.5			$	99.1
Commercial tract sales		18.5				9.1
Other		2.3				1.0
Total revenues		$	428.3			$	109.2
Cost of sales		362.7				69.0
Selling, general and administrative expense		28.9				32.8
Equity in earnings of unconsolidated entities		(0.5		)		(12.4		)
Gain on sale of assets		(3.0		)		(27.7		)
Interest expense		—				5.8
Other (income) expense		(5.5		)		(7.0		)
Income before income taxes		$	45.7			$	48.7

At September 30, 2019, Forestar owned directly or controlled through land and lot purchase contracts approximately 38,300 residential lots, of which approximately 4,400 are fully developed. Approximately 23,400 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 700 of these lots are under contract to sell to other builders.

Residential land and lot sales primarily consist of the sale of single-family lots to local, regional and national homebuilders. During fiscal 2019 and 2018, Forestar’s land and lot sales, including the portion sold to D.R. Horton and the revenues generated from those sales, were as follows:

		Year Ended September 30, 2019				For the Period from October 5, 2017 to September 30, 2018
		(Dollars in millions)
Total residential single-family lots sold		4,132				1,279
Residential single-family lots sold to D.R. Horton		3,728				642
Residential lot sales revenues from sales to D.R. Horton		$	315.7			$	37.1
Residential tract acres sold to D.R. Horton		290				79
Residential land sales revenues from sales to D.R. Horton		$	10.9			$	2.0

SG&A expense for fiscal 2019 and 2018 includes charges of $2.1 million and $0.9 million, respectively, 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. SG&A expense for fiscal 2018 also includes $6.3 million of severance and change of control charges for Forestar’s executive officers that were triggered shortly after the acquisition date.

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

Gain on sale of assets during fiscal 2018 was primarily due to 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.

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, 2019 and 2018.

		Fiscal Year Ended September 30,
		2019			2018			% Change
Number of first-lien loans originated or brokered by DHI Mortgage for D.R. Horton homebuyers		33,024			29,133			13	%
Number of homes closed by D.R. Horton		56,975			51,857			10	%
Percentage of D.R. Horton homes financed by DHI Mortgage		58	%		56	%
Number of total loans originated or brokered by DHI Mortgage for D.R. Horton homebuyers		33,114			29,234			13	%
Total number of loans originated or brokered by DHI Mortgage		33,827			30,107			12	%
Captive business percentage		98	%		97	%
Loans sold by DHI Mortgage to third parties		32,849			29,120			13	%

		Fiscal Year Ended September 30,
		2019				2018				% Change
		(In millions)
Loan origination fees		$	11.7			$	15.0			(22	)%
Sale of servicing rights and gains from sale of mortgage loans		319.4				265.1				20	%
Other revenues		24.4				18.7				30	%
Total mortgage operations revenues		355.5				298.8				19	%
Title policy premiums		86.2				76.5				13	%
Total revenues		441.7				375.3				18	%
General and administrative expense		293.0				272.6				7	%
Other (income) expense		(17.6		)		(15.1		)		17	%
Financial services pre-tax income		$	166.3			$	117.8			41	%

Financial Services Operating Margin Analysis

		Percentages of Financial Services Revenues
		Fiscal Year Ended September 30,
		2019			2018
General and administrative expense		66.3	%		72.6	%
Other (income) expense		(4.0	)%		(4.0	)%
Financial services pre-tax income		37.6	%		31.4	%

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 2019, the volume of first-lien loans originated or brokered by DHI Mortgage for our homebuyers increased 13% from the prior year, primarily as a result of an increase in the number of homes closed by our homebuilding operations of 10%. The percentage of homes closed for which DHI Mortgage handled the homebuyers’ financing was 58% and 56% in fiscal 2019 and 2018, respectively.

Homes closed by our homebuilding operations constituted 98% and 97% of DHI Mortgage loan originations in fiscal 2019 and 2018, respectively. These percentages reflect DHI Mortgage’s consistent focus on the captive business provided by our homebuilding operations.

The number of loans sold increased 13% in fiscal 2019 compared to the prior year. Virtually all of the mortgage loans held for sale on September 30, 2019 were eligible for sale to Fannie Mae, Freddie Mac or Ginnie Mae. Approximately 93% of the mortgage loans sold by DHI Mortgage during fiscal 2019 were sold to four major financial entities, the largest of which purchased 32% of the total loans sold.

Financial Services Revenues and Expenses

Revenues from our mortgage operations increased 19% to $355.5 million in fiscal 2019 from $298.8 million in fiscal 2018, while the number of loan originations increased 12% over that same period. Revenues increased at a higher rate than origination volume primarily due to improved loan sale execution in the secondary market.

Our mortgage operations revenues were reduced by $0.8 million and $1.3 million in fiscal 2019 and 2018, 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 increased 7% to $293.0 million in fiscal 2019 from $272.6 million in the prior year. The increase was primarily due to an increase in employee related costs. Our financial services operations employed 1,924 and 1,919 employees at September 30, 2019 and 2018, respectively.

As a percentage of financial services revenues, G&A expense was 66.3% in fiscal 2019 compared to 72.6% in the prior year. The lower percentage in fiscal 2019 was primarily due to improved loan sale execution on mortgage loan originations and increased mortgage loan origination volume allowing us to better leverage G&A expenses.

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 — Other Businesses

Through DHI Communities, a 100% owned subsidiary, we develop, construct and own multi-family residential properties that produce rental income. DHI Communities is primarily focused on constructing garden style multi-family products, which typically accommodate 200 to 400 dwelling units, in high growth suburban markets. After DHI Communities has completed construction and achieved a stabilized occupancy rate, the property is typically marketed for sale. We currently have four projects under active construction and two projects that are substantially complete, one of which was under contract to sell at September 30, 2019. During fiscal 2019, DHI Communities sold two multi-family rental properties for $133.4 million and recorded gains on sale totaling $51.9 million.

Results of Operations — Consolidated

Income before Income Taxes

Pre-tax income was $2.1 billion in both fiscal 2019 and 2018. In fiscal 2019, our homebuilding, financial services and other businesses generated pre-tax income of $1.9 billion, $166.3 million and $55.5 million, respectively. In fiscal 2018, our homebuilding and financial services businesses generated pre-tax income of $2.0 billion and $117.8 million, respectively.

Income Taxes

Our income tax expense was $506.7 million and $597.7 million in fiscal 2019 and 2018, respectively, and our effective tax rate was 23.8% and 29.0% in those years. The effective tax rates reflect the impact of the Tax Cuts and Jobs Act (Tax Act), which was enacted into law in December 2017. The Tax Act reduced the federal corporate tax rate from 35% to 21% for all corporations effective January 1, 2018. For fiscal year companies, the change in law required 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. For the fiscal year ended September 30, 2019 and thereafter, the applicable statutory federal tax rate is 21%. The Tax Act also repealed the domestic production activities deduction effective for us beginning October 1, 2018. The effective tax rates also include a tax benefit related to stock-based compensation and an expense for state income taxes.

The fiscal year 2018 effective tax rate also included the remeasurement of our deferred tax assets and liabilities as a result of the Tax Act, 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.

Our deferred tax assets, net of deferred tax liabilities, were $181.8 million at September 30, 2019 compared to $211.7 million at September 30, 2018. We have a valuation allowance related to state deferred tax assets for net operating loss (NOL) carryforwards of $18.7 million at September 30, 2019 and $17.7 million at September 30, 2018 related to state deferred tax assets for NOL carryforwards that are more likely than not to expire before being realized. 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 $16.4 million of tax benefits for state NOL carryforwards that expire at various times depending on the tax jurisdiction. Of the total amount, $6.2 million of the tax benefits expire over the next ten years and the remaining $10.2 million expires from fiscal years 2030 to 2039.

Forestar has $11.4 million of tax benefits for federal NOL carryforwards which have no expiration date. Additionally, Forestar has $3.7 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 state income tax in multiple jurisdictions. The statute of limitations for D.R. Horton’s major tax jurisdictions remains open for examination for fiscal years 2016 through 2019. 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 state income tax in multiple jurisdictions. The federal statute of limitations for tax years prior to 2017 is effectively closed. The statute of limitations in major state jurisdictions for tax years prior to 2015 is closed. The Internal Revenue Service recently completed an audit of Forestar’s 2016 tax year with no changes. 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, to increase our investments in homes, finished lots, land and land development to expand our operations and grow our revenues and profitability, as well as to consider opportunistic strategic investments as they arise.

At September 30, 2019, our ratio of debt to total capital (notes payable divided by stockholders’ equity plus notes payable) was 25.3% compared to 26.3% at September 30, 2018. Our ratio of homebuilding debt to total capital (homebuilding notes payable divided by stockholders’ equity plus homebuilding notes payable) was 17.0% compared to 21.4% at September 30, 2018. 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 2020. 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, pay dividends, repurchase our common stock and support other general corporate and operational needs, and we regularly evaluate our opportunities to raise additional capital. D.R. Horton has an automatically effective universal shelf registration statement filed with the SEC in August 2018, registering debt and equity securities that may be issued from time to time in amounts to be determined. Forestar also has an effective shelf registration statement filed with the SEC in September 2018, registering $500 million of equity securities, of which $394.3 million remains available. 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 homebuilding senior notes and $118.9 million principal amount of Forestar’s convertible senior notes in fiscal 2020.

Capital Resources - Homebuilding

Cash and Cash Equivalents — At September 30, 2019, cash and cash equivalents of our homebuilding segment totaled $1.0 billion.

Bank Credit Facility — At September 30, 2019, we had a $1.325 billion senior unsecured homebuilding revolving credit facility with 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 provided 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. At September 30, 2019, there were no borrowings outstanding and $141.2 million of letters of credit issued under the revolving credit facility, resulting in available capacity of approximately $1.2 billion. Borrowings and repayments under the facility totaled $2.1 billion each during fiscal 2019.

In October 2019, the homebuilding revolving credit facility was amended to increase its capacity to $1.59 billion with an uncommitted accordion feature that could increase the size of the facility to $2.5 billion, subject to certain conditions and availability of additional bank commitments. The amendment also extended the facility’s maturity date from September 25, 2023 to October 2, 2024 and increased the letter of credit sublimit to 100% of the revolving credit commitment.

Our homebuilding revolving credit facility imposes restrictions on our operations and activities, including requiring the maintenance of a maximum allowable leverage ratio and a borrowing base restriction if our leverage ratio 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, 2019, we were in compliance with all of the covenants, limitations and restrictions of our homebuilding revolving credit facility.

Public Unsecured Debt — We have $1.95 billion principal amount of homebuilding senior notes outstanding as of September 30, 2019 that mature from February 2020 through August 2023. In March 2019, we repaid $500 million principal amount of our 3.75% senior notes at maturity. The indenture governing our senior notes imposes restrictions on the creation of secured debt and liens. At September 30, 2019, we were in compliance with all of the limitations and restrictions associated with our public debt obligations.

In October 2019, we issued $500 million principal amount of 2.5% senior notes due October 15, 2024, with interest payable semi-annually. The annual effective interest rate of these notes after giving effect to the amortization of the discount and financing costs is 2.7%.

Repurchases of Common Stock — During fiscal 2019, we repurchased 11.9 million shares of our common stock for $479.8 million.

Debt and Equity Repurchase Authorizations — Effective July 30, 2019, our Board of Directors authorized the repurchase of up to $500 million of debt securities and $1.0 billion of our common stock, which replaced the previous authorizations. The new authorizations have no expiration date. At September 30, 2019, the full amount of the debt repurchase authorization was remaining and $895.7 million of the equity repurchase authorization was remaining.

Capital Resources - Forestar

At September 30, 2019, Forestar had cash and cash equivalents of $382.8 million. Forestar obtained a $380 million senior unsecured bank credit facility in August 2018 and issued $350 million principal amount of senior notes in April 2019. In September 2018, Forestar filed an effective shelf registration statement with the SEC, registering $500 million of equity securities, and in September 2019, Forestar issued common stock that provided net proceeds of $100.7 million. Forestar’s ability to achieve its long-term growth objectives will depend on its ability 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.

Bank Credit Facility — Forestar has 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. Letters of credit issued under the facility reduce the available borrowing capacity. At September 30, 2019, there were no borrowings outstanding and $29.7 million of letters of credit issued under the revolving credit facility. 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. At September 30, 2019, the borrowing base limited the available capacity under the revolving credit facility to $339.6 million. Borrowings and repayments under the facility totaled $85 million each during fiscal 2019.

In October 2019, the Forestar revolving credit facility was amended to extend its maturity date from August 16, 2021 to October 2, 2022. The maturity date may be extended by up to one year on up to two additional occasions, subject to the approval of lenders holding a majority of the commitments.

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, 2019, Forestar was in compliance with all of the covenants, limitations and restrictions of its revolving credit facility.

Unsecured Debt — Forestar has $118.9 million principal amount of 3.75% convertible senior notes outstanding as of September 30, 2019 that are expected to be settled in cash upon their maturity on March 1, 2020. In April 2019, Forestar issued $350 million principal amount of 8.0% senior notes pursuant to Rule 144A and Regulation S under the Securities Act of 1933, as amended. The notes mature April 15, 2024, with interest payable semi-annually and represent unsecured obligations of Forestar. The annual effective interest rate of these notes after giving effect to the amortization of financing costs is 8.5%. These notes may be redeemed prior to maturity, subject to certain limitations and premiums defined in the indenture agreement.

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

Equity Offering — On September 30, 2019, Forestar issued 6.0 million shares of its common stock for $17.50 per share in a public underwritten offering. Net proceeds to Forestar from this offering after deducting underwriting discounts and commissions and other expenses were $100.7 million. As a result of the issuance, our ownership of Forestar's outstanding common shares decreased from 75% to approximately 66%. Following the offering, $394.3 million remains available for issuance under Forestar’s shelf registration statement.

Capital Resources - Financial Services

Cash and Cash Equivalents — At September 30, 2019, cash and cash equivalents of our financial services operations totaled $43.4 million.

Mortgage Repurchase Facility — Our mortgage subsidiary, DHI Mortgage, has a mortgage repurchase facility that provides financing and liquidity to DHI Mortgage by facilitating purchase transactions in which DHI Mortgage transfers eligible loans to the counterparties upon receipt of funds from the counterparties. 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 $900 million; however, the capacity increases, without requiring additional commitments, to $1.1 billion for approximately 45 days at fiscal year end. The capacity of the facility can also be increased to $1.2 billion subject to the availability of additional commitments. The maturity date of the facility is February 21, 2020.

As of September 30, 2019, $1.0 billion of mortgage loans held for sale with a collateral value of $972.0 million were pledged under the mortgage repurchase facility. DHI Mortgage had an obligation of $888.9 million outstanding under the mortgage repurchase facility at September 30, 2019 at a 3.7% 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 leverage ratio and its minimum required liquidity. These covenants are measured and reported to the lenders monthly. At September 30, 2019, 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 2019, net cash provided by operating activities was $892.1 million compared to $545.2 million in fiscal 2018. Cash provided by operating activities in the current year consisted of $1.4 billion of cash provided by our homebuilding segment, partially offset by $395.7 million and $150.2 million of cash used in our Forestar and financial services segments, respectively.

Cash provided from a decrease in construction in progress and finished homes inventory was $84.6 million in fiscal 2019 as our homes in inventory at September 30, 2019 remained relatively flat with the prior year. Cash used to increase construction in progress and finished homes inventory was $482.8 million in fiscal 2018 as our homes in inventory increased by approximately 3,300 homes at September 30, 2018 compared to September 30, 2017. During fiscal 2019, cash used to increase residential land and lots was $676.4 million compared to $573.8 million in fiscal 2018. Of these amounts, $513.2 million and $393.2 million, respectively, related to Forestar. The most significant source of cash provided by operating activities in all years was net income.

Investing Cash Flow Activities

In fiscal 2019, net cash used in investing activities was $394.0 million compared to cash provided by investing activities of $19.0 million in fiscal 2018. In fiscal 2019, we paid $315.8 million to purchase the homebuilding operations of Westport Homes, Classic Builders and Terramor Homes. Proceeds from the sale of assets in fiscal 2019 included $133.4 million related to the sale of two multi-family rental properties constructed by DHI Communities. 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. Proceeds from the sale of assets in fiscal 2018 included $258.3 million related to Forestar, primarily from the strategic sale of assets.

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 capital markets.

In fiscal 2019, net cash used in financing activities was $490.1 million, consisting primarily of note repayments, repurchases of common stock and payments of cash dividends, largely offset by note proceeds. Note repayments of $2.7 billion included repayments of amounts drawn on our revolving credit facilities of $2.2 billion and repayment of $500 million principal amount of our 3.75% homebuilding senior notes at maturity. We also used cash of $479.8 million to repurchase 11.9 million shares of our common stock and used $223.4 million to pay dividends to our common stockholders. Note proceeds of $2.5 billion included draws of $2.2 billion on our revolving credit facilities and Forestar’s issuance of $350 million principal amount of 8.0% senior notes due April 2024. Our financial services segment received proceeds of $251.2 million from net advances under its mortgage repurchase facility. Additionally, Forestar’s issuance of common stock resulted in $100.7 million of cash proceeds.

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

Our Board of Directors approved and paid quarterly cash dividends of $0.15 per common share in fiscal 2019 and $0.125 per common share in fiscal 2018. In November 2019, our Board of Directors approved a cash dividend of $0.175 per common share, payable on December 11, 2019, to stockholders of record on November 27, 2019. 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, 2019 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)	$	3,410.9			$	1,605.3			$	753.7			$	1,051.9			$	—
Notes Payable — Interest (1)	367.2				134.0				162.2				71.0				—
Operating Leases	42.5				18.6				18.2				5.5				0.2
Purchase Obligations (2)	59.8				48.2				11.6				—				—
	$	3,880.4			$	1,806.1			$	945.7			$	1,128.4			$	0.2

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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, 2019, 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 3.7% and principal balance outstanding at September 30, 2019.

(2)

Purchase obligations relate to our land and lot purchase contracts which enable us to control significant lot positions with limited capital investment. Among our homebuilding land and lot purchase contracts at September 30, 2019, there were a limited number of contracts, representing $59.8 million of remaining purchase price, subject to specific performance provisions that may require us to purchase the land or lots upon the land sellers meeting their respective contractual obligations. Of this amount, $13.2 million related to contracts between our homebuilding segment and Forestar. Further information about our land purchase contracts is provided in the “Homebuilding Inventories, Land and Lot Position and Homes in Inventory” section included herein.

At September 30, 2019, we had outstanding letters of credit of $171.7 million and surety bonds of $1.7 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 our homebuilding, land development 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,” “continue,” “could,” “estimate,” “expect,” “forecast,” “goal,” “intend,” “likely,” “may,” “outlook,” “plan,” “possible,” “potential,” “predict,” “projection,” “seek,” “should,” “strategy,” “target,” “will,” “would” 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 and lot development industries 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 ability to manage and service our debt and 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, 2019 and 2018, and for the years ended September 30, 2019, 2018 and 2017. 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. Our performance obligation, to deliver the agreed-upon home, is generally satisfied in less than one year from the original contract date. Proceeds from home closings held for our benefit at title companies are included in homebuilding cash and cash equivalents in the consolidated balance sheets.

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 rarely purchase land for resale, but periodically may elect to sell parcels of land that no longer fit into our strategic operating plans. Revenue from land sales is typically recognized on the closing date, which is generally when performance obligations are satisfied.

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. Revenues associated with our mortgage operations primarily include net gains on the sale of mortgage loans and servicing rights. We typically elect the fair value option for our mortgage loan originations whereby mortgage loans held for sale are recorded at fair value based on either sale commitments or current market quotes and loan values are adjusted through revenues for subsequent changes in fair value until the loans are sold. Expected gains and losses from the sale of servicing rights are included in the measurement of all written loan commitments that are accounted for at fair value through revenues 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.

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 volume of 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.

We collect insurance commissions on homeowner policies placed with third party carriers through our 100% owned insurance agency. We recognize revenue and a contract asset for estimated future renewals of these policies upon issuance of the initial policy, the date at which the performance obligation is satisfied.

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. Cost of sales for lots sold includes all applicable land acquisition, land development and related costs (both incurred and estimated to be incurred) allocated to each residential lot in the community. Any changes to the estimated total development costs subsequent to the initial home or lot closings in a community are generally allocated on a pro-rata basis to the remaining homes or lots 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 2019, 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 five years, and we utilized a range of discount rates for communities from 12% 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.

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% of these reserves related to construction defect matters at both September 30, 2019 and 2018.

Our reserves for construction defect claims include the estimated costs of both known claims and anticipated future claims. At September 30, 2019 and 2018, we had reserves for approximately 180 and 155 pending construction defect claims, respectively, and no individual existing claim was material to our financial statements. During fiscal 2019, we established reserves for approximately 110 new construction defect claims and resolved 85 construction defect claims for a total cost of $17.9 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. We also believe that fluctuations in housing market 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 $73.7 million in our reserves and a $35.3 million increase in our receivable, resulting in additional expense of $38.4 million. A 10% decrease in the claim frequency and the average cost per claim would result in a decrease of approximately $66.3 million in our reserves and a $27.9 million decrease in our receivable, resulting in a reduction in expense of $38.4 million.

Pending Accounting Pronouncements

In February 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (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 and will not have a material impact on our consolidated financial position, results of operations or 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 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.