Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

(dollars in thousands, except per share data)

Results of Operations for the Years Ended December 31, 2017, 2016 and 2015

Overview

Business

Our primary business is the construction and sale of single-family detached homes, townhomes and condominium buildings, all of which are primarily constructed on a pre-sold basis. To fully serve customers of our homebuilding operations, we also operate a mortgage banking and title services business. We primarily conduct our operations in mature markets. Additionally, we generally grow our business through market share gains in our existing markets and by expanding into markets contiguous to our current active markets. Our four homebuilding reportable segments consist of the following regions:

Mid Atlantic:		Maryland, Virginia, West Virginia, Delaware and Washington, D.C.
North East:		New Jersey and Eastern Pennsylvania
Mid East:		New York, Ohio, Western Pennsylvania, Indiana and Illinois
South East:		North Carolina, South Carolina, Florida and Tennessee

Our lot acquisition strategy is predicated upon avoiding the financial requirements and risks associated with direct land ownership and development. We generally do not engage in land development (see discussion below of our land development activities). Instead, we typically acquire finished lots at market prices from various third party land developers pursuant to Lot Purchase Agreements. These Lot Purchase Agreements require deposits, typically ranging up to 10% of the aggregate purchase price of the finished lots, in the form of cash or letters of credit that may be forfeited if we fail to perform under the Lot Purchase Agreement. This strategy has allowed us to maximize inventory turnover, which we believe enables us to minimize market risk and to operate with less capital, thereby enhancing rates of return on equity and total capital.

In addition to constructing homes primarily on a pre-sold basis and utilizing what we believe is a conservative lot acquisition strategy, we focus on obtaining and maintaining a leading market position in each market we serve. This strategy allows us to gain valuable efficiencies and competitive advantages in our markets, which we believe contributes to minimizing the adverse effects of regional economic cycles and provides growth opportunities within these markets. Our continued success is contingent upon our ability to control an adequate supply of finished lots on which to build.

In certain specific strategic circumstances, we deviate from our historical lot acquisition strategy and engage in joint venture arrangements with land developers or directly acquire raw ground already zoned for its intended use for development. Once we acquire control of raw ground, we determine whether to sell the raw parcel to a developer and enter into a Lot Purchase Agreement with the developer to purchase the finished lots or to hire a developer to develop the land on our behalf. While joint venture arrangements and direct land development activity are not our preferred method of acquiring finished building lots, we may enter into additional transactions in the future on a limited basis where there exists a compelling strategic or prudent financial reason to do so. We expect, however, to continue to acquire substantially all of our finished lot inventory using Lot Purchase Agreements with forfeitable deposits.

As of December 31, 2017, we controlled lots as described below.

Lot Purchase Agreements

We controlled approximately 84,300 lots under Lot Purchase Agreements with third parties through deposits in cash and letters of credit totaling approximately $393,900 and $1,900, respectively. Included in the number of controlled lots are approximately 4,600 lots for which we have recorded a contract land deposit impairment reserve of approximately $30,000 as of December 31, 2017.

Joint Venture Limited Liability Corporations (“JVs”)

We had an aggregate investment totaling approximately $45,500 in six JVs, expected to produce approximately 7,300 lots. Of the lots to be produced by the JVs, approximately 3,900 lots were controlled by us and approximately 3,400 lots were either under contract with unrelated parties or currently not under contract.

Land Under Development

We directly owned four separate raw land parcels, zoned for their intended use, with a current cost basis, including development costs, of approximately $34,200 that we intend to develop into approximately 500 finished lots. We had additional funding commitments of approximately $7,900 under a joint development agreement related to one parcel, a portion of which we expect will be offset by development credits of approximately $4,700.

See Notes 3, 4 and 5 to the consolidated financial statements included herein for additional information regarding Lot Purchase Agreements, JVs and land under development, respectively.

Raw Land Purchase Agreements

In addition to the lots we currently control as discussed above, we have certain properties under contract with land owners that are expected to yield approximately 10,700 lots. Some of these properties may require rezoning or other approvals to achieve the expected yield. These properties are controlled with cash deposits and letters of credit totaling approximately $6,600 and $100, respectively, as of December 31, 2017, of which approximately $5,800 is refundable if we do not perform under the contract. We generally expect to assign the raw land contracts to a land developer and simultaneously enter into a Lot Purchase Agreement with the assignee if the project is determined to be feasible.

Current Business Environment and Key Financial Results

During 2017, we continued to experience improving new home demand as a result of favorable market conditions, including low mortgage interest rates, low unemployment and improved consumer confidence. However, new home prices continued to be constrained due to the competitive market environment.

Our consolidated revenues for the year ended December 31, 2017 totaled $6,305,840, an increase of 8% from $5,822,544 in 2016. Our net income for 2017 was $537,521, or $126.77 per diluted share, increases of 26% and 22% compared to 2016 net income and diluted earnings per share, respectively. Our homebuilding gross profit margin percentage increased to 19.2% in 2017 from 17.5% in 2016. New orders, net of cancellations (“New Orders”) during 2017 increased 13% from 2016 while our average New Order sales price decreased 1% to $383.2 in 2017. Our backlog of homes sold but not yet settled with the customer as of December 31, 2017 increased on a unit basis by 24% to 8,531 units and increased on a dollar basis by 21% to $3,277,888 when compared to December 31, 2016.

We believe that a continuation of the housing market recovery is dependent upon sustained economic growth, driven by continued improvements in job and wage growth and household formation. We expect to continue to face gross profit margin pressure which will be impacted by modest pricing power and our ability to manage land and construction costs. We also expect to face pressure on mortgage banking profit due to the competitive pricing pressures in the mortgage market. We believe that we are well positioned to take advantage of opportunities that may arise from future economic and homebuilding market volatility due to the strength of our balance sheet.

Homebuilding Operations

The following table summarizes the results of our consolidated homebuilding operations and certain operating activity for each of the last three years:

		Year Ended December 31,
		2017				2016				2015
Financial data:
Revenues		$	6,175,521			$	5,709,223			$	5,065,200
Cost of sales		$	4,990,378			$	4,707,861			$	4,118,782
Gross profit margin percentage		19.2		%		17.5		%		18.7		%
Selling, general and administrative expenses		$	392,272			$	382,459			$	371,127
Operating data:
New orders (units)		17,608				15,583				14,080
Average new order price		$	383.2			$	386.4			$	378.7
Settlements (units)		15,961				14,928				13,326
Average settlement price		$	386.9			$	381.2			$	379.9
Backlog (units)		8,531				6,884				6,229
Average backlog price		$	384.2			$	392.8			$	381.3
New order cancellation rate		14.0		%		15.5		%		14.5		%

Consolidated Homebuilding

2017 versus 2016

Homebuilding revenues increased 8% in 2017 compared to 2016, primarily as a result of a 7% increase in the number of units settled year over year. The increase in the number of units settled was primarily attributable to an 11% higher backlog unit balance entering 2017 compared to the backlog unit balance entering 2016, offset partially by a lower backlog turnover rate year over year.

Gross profit margin percentage in 2017 increased to 19.2% from 17.5% in 2016, due primarily to modest improvement in pricing, moderating construction costs and the increase in the number of units settled, which allowed us to better leverage certain operating costs.

The number of New Orders increased 13% while the average sales price of New Orders decreased 1% in 2017 when compared to 2016. New Orders increased in each of our market segments due to more favorable market conditions in 2017 compared to 2016, which led to higher community absorption rates year over year.

Selling, general and administrative ("SG&A") expenses in 2017 increased by 3% compared to 2016, but as a percentage of revenue decreased to 6.4% in 2017 from 6.7% in 2016. SG&A expenses as a percentage of revenue were favorably impacted by the 8% increase in revenues.

Backlog units and dollars were 8,531 units and $3,277,888, respectively, as of December 31, 2017 compared to 6,884 units and $2,704,277, respectively, as of December 31, 2016. The 24% increase in backlog units was primarily attributable to a 19% increase in New Orders for the six-month period ended December 31, 2017 compared to the same period in 2016. Backlog dollars were favorably impacted by the increase in backlog units.

Backlog may be impacted by customer cancellations for various reasons that are beyond our control, such as failure to obtain mortgage financing, inability to sell an existing home, job loss, or a variety of other reasons. In any period, a portion of the cancellations that we experience are related to new sales that occurred during the same period, and a portion are related to sales that occurred in prior periods and therefore appeared in the beginning backlog for the current period. Expressed as the total of all cancellations during the period as a percentage of gross sales during the period, our cancellation rate was approximately 14% in 2017 and approximately 15% in both 2016 and 2015. Additionally, during each of 2017, 2016 and 2015, approximately 6% of a reporting quarter’s opening backlog cancelled during the quarter. We can provide no assurance that our historical cancellation rates are indicative of the actual cancellation rate that may occur in future years. Other than those units that are cancelled, we expect to settle substantially all of our December 31, 2017 backlog during 2018. See “Risk Factors” in Item 1A of this Form 10-K.

The backlog turnover rate is impacted by various factors, including, but not limited to, changes in New Order activity, internal production capacity, external subcontractor capacity and other external factors over which we do not exercise control.

2016 versus 2015

Homebuilding revenues increased 13% in 2016 compared to 2015, primarily as a result of a 12% increase in the number of units settled year over year. The increase in the number of units settled was attributable to a 14% higher backlog unit balance entering 2016 compared to backlog entering 2015. In addition, the number of units settled was favorably impacted by a 10% increase in New Orders for the first six months of 2016 compared to the same period in 2015.

The number of New Orders and the average sales price of New Orders increased 11% and 2%, respectively, in 2016 compared to 2015. New Orders and the average sales price of New Orders increased in each of our market segments due to more favorable market conditions in 2016 compared to 2015, which led to a higher sales absorption rate year over year. Additionally, New Orders were favorably impacted by a 3% increase in the average number of active communities year over year.

Gross profit margin percentage in 2016 decreased to 17.5% from 18.7% in 2015, due to higher construction and selling related costs year over year.

SG&A expenses in 2016 increased approximately $11,300, or 3% compared to 2015, but as a percentage of revenue decreased to 6.7% from 7.3% year over year. SG&A expenses increased primarily due to an approximate $10,500 increase in marketing costs attributable to the 3% increase in the number of active communities year over year and higher spending levels.

Backlog units and dollars were 6,884 units and $2,704,277, respectively, as of December 31, 2016 compared to 6,229 units and $2,375,182, respectively, as of December 31, 2015. The 11% increase in backlog units was primarily attributable to a 12% increase in New Orders for the six month period ended December 31, 2016 compared to the same period in 2015. The 14% increase in backlog dollars was attributable to the increase in backlog units coupled with a 3% increase in the average New Order sales price for the six month period ended December 31, 2016 compared to the same period in 2015.

Reportable Homebuilding Segments

Homebuilding profit before tax includes all revenues and income generated from the sale of homes, less the cost of homes sold, SG&A expenses, and a corporate capital allocation charge determined by corporate management. The corporate capital allocation charge eliminates in consolidation and is based on the segment’s average net assets employed. The corporate capital allocation charged to the operating segment allows the Chief Operating Decision Maker to determine whether the operating segment’s results are providing the desired rate of return after covering our cost of capital.

We record charges on contract land deposits when we determine that it is probable that recovery of the deposit is impaired. For segment reporting purposes, impairments on contract land deposits are generally charged to the operating segment upon the determination to terminate a Lot Purchase Agreement with the developer or to restructure a Lot Purchase Agreement resulting in the forfeiture of the deposit. For presentation purposes below, the contract land deposit reserve at December 31, 2017 and 2016 has been allocated to the reportable segments for the respective years to show contract land deposits on a net basis. The net contract land

deposit balances below also include approximately $2,000 and $2,400 at December 31, 2017 and 2016, respectively, of letters of credit issued as deposits in lieu of cash.

The following tables summarize certain homebuilding operating activity by reportable segment for each of the last three years:

Selected Segment Financial Data:

		Year Ended December 31,
		2017				2016				2015
Revenues:
Mid Atlantic		$	3,543,687			$	3,319,776			$	3,022,789
North East		517,141				462,385				432,145
Mid East		1,250,165				1,192,472				1,014,920
South East		864,528				734,590				595,346

		Year Ended December 31,
		2017				2016				2015
Gross profit margin:
Mid Atlantic		$	663,650			$	561,857			$	563,299
North East		104,501				68,808				79,588
Mid East		244,832				215,335				178,508
South East		173,961				137,787				113,210

		Year Ended December 31,
		2017			2016			2015
Gross profit margin percentage:
Mid Atlantic		18.7	%		16.9	%		18.6	%
North East		20.2	%		14.9	%		18.4	%
Mid East		19.6	%		18.1	%		17.6	%
South East		20.1	%		18.8	%		19.0	%

		Year Ended December 31,
		2017				2016				2015
Segment profit:
Mid Atlantic		$	398,494			$	301,173			$	322,829
North East		60,218				21,947				37,914
Mid East		149,639				121,166				86,336
South East		95,826				71,098				57,384

Segment Operating Activity:

		Year Ended December 31,
		2017							2016							2015
		Units			Average Price				Units			Average Price				Units			Average Price
New orders, net of cancellations:
Mid Atlantic		8,654			$	438.9			7,916			$	443.1			7,070			$	439.5
North East		1,362			$	409.7			1,314			$	387.1			1,173			$	365.9
Mid East		4,171			$	332.7			3,659			$	329.2			3,485			$	321.4
South East		3,421			$	293.5			2,694			$	296.9			2,352			$	287.3
Total		17,608			$	383.2			15,583			$	386.4			14,080			$	378.7

		Year Ended December 31,
		2017							2016							2015
		Units			Average Price				Units			Average Price				Units			Average Price
Settlements:
Mid Atlantic		7,971			$	444.5			7,512			$	439.6			6,879			$	439.2
North East		1,288			$	401.5			1,246			$	371.1			1,221			$	353.9
Mid East		3,772			$	331.4			3,658			$	325.7			3,137			$	323.5
South East		2,930			$	295.1			2,512			$	292.4			2,089			$	284.9
Total		15,961			$	386.9			14,928			$	381.2			13,326			$	379.9

		Year Ended December 31,
		2017							2016							2015
		Units			Average Price				Units			Average Price				Units			Average Price
Backlog:
Mid Atlantic		4,224			$	432.2			3,541			$	443.4			3,137			$	435.3
North East		682			$	424.3			608			$	408.7			540			$	374.7
Mid East		1,898			$	341.2			1,499			$	340.1			1,498			$	331.7
South East		1,727			$	298.4			1,236			$	304.1			1,054			$	294.6
Total		8,531			$	384.2			6,884			$	392.8			6,229			$	381.3

Operating Data:

		Year Ended December 31,
		2017			2016			2015
New order cancellation rate:
Mid Atlantic		15.2	%		15.7	%		15.2	%
North East		13.3	%		15.1	%		14.3	%
Mid East		11.5	%		14.4	%		13.4	%
South East		14.3	%		16.5	%		14.2	%

		Year Ended December 31,
		2017			2016			2015
Average active communities:
Mid Atlantic		238			239			233
North East		42			42			38
Mid East		121			128			130
South East		84			76			71
Total		485			485			472

Homebuilding Inventory:

		As of December 31,
		2017				2016
Sold inventory:
Mid Atlantic		$	617,471			$	544,840
North East		96,412				79,751
Mid East		173,572				141,033
South East		151,219				107,967
Total (1)		$	1,038,674			$	873,591

		As of December 31,
		2017				2016
Unsold lots and housing units inventory:
Mid Atlantic		$	118,209			$	117,920
North East		6,666				6,370
Mid East		7,112				7,218
South East		13,511				10,872
Total (1)		$	145,498			$	142,380

(1)	Total segment inventory differs from consolidated inventory due to certain consolidation adjustments necessary to convert the reportable segments’ results, which are predominantly maintained on a cash basis, to a full accrual basis for external financial statement presentation purposes. These consolidation adjustments are not allocated to our operating segments.

Lots Controlled and Land Deposits:

		As of December 31,
		2017			2016
Total lots controlled:
Mid Atlantic		38,450			35,350
North East		7,000			6,200
Mid East		22,250			19,050
South East		21,000			17,400
Total		88,700			78,000

		As of December 31,
		2017				2016
Contract land deposits, net:
Mid Atlantic		$	209,759			$	239,588
North East		29,851				27,648
Mid East		49,838				44,394
South East		82,977				70,593
Total		$	372,425			$	382,223

		Year Ended December 31,
		2017				2016				2015
Contract land deposit impairments, net:
Mid Atlantic		$	2,945			$	2,240			$	1,840
North East		290				3,530				279
Mid East		11				303				409
South East		99				791				250
Total		$	3,345			$	6,864			$	2,778

Mid Atlantic

2017 versus 2016

The Mid Atlantic segment had an approximate $97,300, or 32%, increase in segment profit in 2017 compared to 2016. The increase in segment profit was driven by an increase of segment revenues of approximately $223,900, or 7%, and improved gross profit margins year over year. Segment revenues increased due primarily to a 6% increase in the number of units settled year over year. The increase in the number of units settled was favorably impacted by a 13% higher backlog unit balance entering 2017 compared to the backlog unit balance entering 2016, partially offset by a lower backlog turnover rate. The Mid Atlantic segment’s gross profit margin percentage increased to 18.7% in 2017 from 16.9% in 2016, due primarily to modest improvement in pricing and moderating construction costs.

Segment New Orders increased 9% while the the average sales price of New Orders decreased 1% in 2017 compared to 2016. The increase in New Orders was due to more favorable market conditions in 2017, which led to higher community absorption rates year over year. The decrease in the average sales price of New Orders is attributable to a shift in New Orders to lower priced products.

2016 versus 2015

The Mid Atlantic segment had an approximate $21,700, or 7%, decrease in segment profit in 2016 compared to 2015, despite an increase in segment revenues of approximately $297,000, or 10%, year over year. Segment revenues increased due primarily to a 9% increase in the number of units settled in 2016 compared to 2015. The number of units settled was favorably impacted by a 6% higher backlog unit balance entering 2016 compared to 2015. In addition, units settled in 2016 were favorably impacted by an 11% increase in New Orders for the first six months of 2016 compared to the same period in 2015. The Mid Atlantic segment’s gross profit margin percentage decreased to 16.9% in 2016 from 18.6% in 2015. Segment profit and gross profit margin were negatively impacted primarily by higher construction and selling related costs.

Segment New Orders and the average sales price for New Orders in 2016 increased 12% and 1%, respectively, compared to the same period in 2015. New Orders increased due to favorable market conditions in 2016 compared to 2015, which led to a higher sales absorption rate year over year. Additionally, segment New Orders were favorably impacted by a 3% increase in the average number of active communities year over year.

North East

2017 versus 2016

The North East segment had an approximate $38,300, or 174%, increase in segment profit in 2017 compared to 2016 due to an increase in segment revenues of approximately $54,800, or 12%, and improved gross profit margins year over year. The increase in segment revenues was due to a 3% increase in the number of units settled and an 8% increase in the average settlement price year over year. The increase in the number of units settled was primarily attributable to a 13% higher backlog unit balance entering 2017 compared to the backlog unit balance entering 2016, partially offset by a lower backlog turnover rate year over year. The increase in the average settlement price was attributable to a 9% higher average sales price of units in backlog entering 2017 compared to the same period in 2016, driven by a shift to higher priced markets in the segment and a shift to higher priced communities within certain markets. The North East segment’s gross profit margin percentage increased to 20.2% in 2017 from 14.9% in 2016. Gross profit margin and segment profit were favorably impacted by improvement in pricing, moderating construction costs and the increase in the number of units settled, which allowed us to better leverage certain operating costs.

Segment New Orders and the average sales price of New Orders increased 4% and 6%, respectively, in 2017 compared to 2016. New Orders were favorably impacted by more favorable market conditions in 2017, which led to higher community absorption rates year over year. The increase in the average New Order sales price year over year, was attributable to a shift in New Orders to higher priced markets within the segment and a shift to higher priced communities within certain markets.

2016 versus 2015

The North East segment had an approximate $16,000, or 42%, decrease in segment profit in 2016 compared to 2015, despite an increase in segment revenues of approximately $30,200, or 7%, year over year. Segment revenues increased due to a 2% increase in the number of units settled and a 5% increase in the average settlement price. The increase in the number of units settled and average settlement price was primarily attributable to a 4% increase in both segment New Orders and average sales price of New Orders for the first six months of 2016 compared to the same period in 2015. The North East segment’s gross profit margin percentage decreased to 14.9% in 2016 from 18.4% in 2015. Segment profit and gross profit margin were negatively impacted primarily by higher construction costs, warranty costs and contract land deposit impairments year over year.

Segment New Orders and the average sales price of New Orders in 2016 increased 12% and 6%, respectively, compared to 2015. New Orders were favorably impacted by a 12% increase in the average number of active communities year over year. The increase in the average sales price of New Orders is primarily attributable to a shift in New Orders to higher priced markets in 2016 compared to 2015.

Mid East

2017 versus 2016

The Mid East segment had an approximate $28,500, or 23%, increase in segment profit in 2017 compared to 2016. The increase in segment profit was driven by an increase of approximately $57,700, or 5%, in revenues and improved gross profit margins year over year. The increase in revenues was due to a 3% increase in the number of units settled and a 2% increase in the average settlement price. The increases in the number of units settled and average settlement price were primarily attributable to an 11% increase in segment New Orders and a 2% increase in the average sales price of New Orders for the first six months of 2017 compared to the same period in 2016. The segment’s gross profit margin percentage increased to 19.6% in 2017 from 18.1% in 2016, primarily due to modest improvement in pricing and moderating construction costs year over year.

Segment New Orders and the average sales price of New Orders increased 14% and 1%, respectively, in 2017 compared to 2016. New Orders increased despite a 5% decrease in the average number of active communities year over year as more favorable market conditions in 2017 led to higher community absorption rates within the segment.

2016 versus 2015

The Mid East segment had an approximate $34,800, or 40%, increase in segment profit in 2016 compared to 2015. The increase in segment profit was driven by an increase in segment revenues of approximately $177,600, or 17%, year over year due to a 17% increase in the number of units settled in 2016. The number of units settled was favorably impacted by a 30% higher backlog unit balance entering 2016 compared to 2015. The segment’s gross profit margin percentage increased to 18.1% in 2016 from 17.6% in 2015, due primarily to increased settlement activity, which allowed us to better leverage certain operating costs in 2016.

Segment New Orders and the average sales price of New Orders in 2016 increased 5% and 2%, respectively, compared to 2015. New Orders were favorably impacted by favorable market conditions in 2016 compared to 2015, which led to a higher sales absorption rate year over year.

South East

2017 versus 2016

The South East segment had an approximate $24,700, or 35%, increase in segment profit in 2017 compared to 2016. The increase in segment profit was primarily driven by an increase of approximately $129,900, or 18%, in revenues and improved gross profit margins. The increase in revenues was primarily attributable to a 17% increase in the number of units settled. The increase in settlements was attributable to a 17% higher backlog unit balance entering 2017 compared to the backlog unit balance entering 2016. The South East segment’s gross profit margin percentage increased to 20.1% in 2017 from 18.8% in 2016 primarily due to modest improvement in pricing, partially offset by higher construction costs year over year.

Segment New Orders increased 27%, while the average sales price of New Orders decreased 1% in 2017 compared to 2016. New Orders were favorably impacted by a 10% increase in the average number of active communities in 2017 compared to 2016 and more favorable market conditions in 2017, which led to higher community absorption rates. The average sales price of New Orders was negatively impacted by a shift in sales to lower priced markets within the South East segment.

2016 versus 2015

The South East segment had an approximate $13,700, or 24%, increase in segment profit in 2016 compared to 2015. The increase in segment profit was driven by an increase in segment revenues of approximately $139,200, or 23%, year over year due to a 20% increase in the number of units settled and a 3% increase in the average settlement price. The increase in the number of units settled was attributable to a 33% higher backlog unit balance entering 2016 compared to 2015. In addition, the settlements and the average settlement price increases were favorably impacted by a 16% increase in New Orders and a 4% increase in the average sales price of New Orders, respectively, for the first six months of 2016 compared to the same period in 2015. The South East segment’s gross profit margin percentage decreased to 18.8% in 2016 from 19.0% in 2015, due to higher lot and selling related costs year over year, offset partially by improved leveraging of certain operating costs due to the increase in settlement activity in 2016.

Segment New Orders and the average sales price of New Orders increased 15% and 3%, respectively, in 2016 compared to 2015. New Orders were favorably impacted by a 7% increase in the average number of active communities year over year, and by more favorable market conditions in 2016, which led to a higher sales absorption rate year over year.

Homebuilding Segment Reconciliations to Consolidated Homebuilding Operations

In addition to the corporate capital allocation and contract land deposit impairments discussed above, the other reconciling items between homebuilding segment profit and homebuilding consolidated profit before tax include unallocated corporate overhead (which includes all management incentive compensation), equity-based compensation expense, consolidation adjustments and external corporate interest expense. Our overhead functions, such as accounting, treasury and human resources, are centrally performed and the costs are not allocated to our operating segments. Consolidation adjustments consist of such items to convert the reportable segments’ results, which are predominantly maintained on a cash basis, to a full accrual basis for external financial statement presentation

purposes, and are not allocated to our operating segments. External corporate interest expense is primarily comprised of interest charges on our 3.95% Senior Notes due 2022 (the “Senior Notes”), and is not charged to the operating segments because the charges are included in the corporate capital allocation discussed above.

		Year Ended December 31,
		2017				2016				2015
Homebuilding consolidated gross profit:
Mid Atlantic		$	663,650			$	561,857			$	563,299
North East		104,501				68,808				79,588
Mid East		244,832				215,335				178,508
South East		173,961				137,787				113,210
Consolidation adjustments and other		(1,801		)		17,575				11,813
Homebuilding consolidated gross profit		$	1,185,143			$	1,001,362			$	946,418

		Year Ended December 31,
		2017				2016				2015
Homebuilding consolidated profit before taxes:
Mid Atlantic		$	398,494			$	301,173			$	322,829
North East		60,218				21,947				37,914
Mid East		149,639				121,166				86,336
South East		95,826				71,098				57,384
Reconciling items:
Contract land deposit impairment reserve (1)		1,307				10,933				13,805
Equity-based compensation expense		(41,144		)		(40,482		)		(50,738		)
Corporate capital allocation (2)		198,384				189,992				171,170
Unallocated corporate overhead		(89,514		)		(89,376		)		(83,124		)
Consolidation adjustments and other		26,143				35,204				22,622
Corporate interest expense		(22,983		)		(20,553		)		(22,869		)
Reconciling items sub-total		72,193				85,718				50,866
Homebuilding consolidated profit before taxes		$	776,370			$	601,102			$	555,329

(1)	This item represents changes to the contract land deposit impairment reserve, which are not allocated to the reportable segments.

(2)	This item represents the elimination of the corporate capital allocation charge included in the respective homebuilding reportable segments. The corporate capital allocation charge is based on the segment’s monthly average asset balance and is as follows for the years presented:

		Year Ended December 31,
		2017				2016				2015
Corporate capital allocation charge:
Mid Atlantic		$	123,028			$	119,758			$	107,705
North East		16,115				18,132				16,987
Mid East		29,663				28,303				27,263
South East		29,578				23,799				19,215
Total corporate capital allocation charge		$	198,384			$	189,992			$	171,170

Mortgage Banking Segment

We conduct our mortgage banking activity through NVRM, a wholly owned subsidiary. NVRM focuses almost exclusively on serving the homebuilding segment customer base. The following table summarizes the results of our mortgage banking operations and certain statistical data for each of the last three years:

		Year Ended December 31,
		2017				2016				2015
Loan closing volume:
Total principal		$	4,229,507			$	3,952,575			$	3,492,342
Loan volume mix:
Adjustable rate mortgages		9		%		5		%		14		%
Fixed-rate mortgages		91		%		95		%		86		%
Operating profit:
Segment profit		$	73,959			$	63,711			$	51,236
Equity-based compensation expense		(3,418		)		(3,116		)		(3,353		)
Mortgage banking income		$	70,541			$	60,595			$	47,883
Capture rate:		88		%		88		%		88		%
Mortgage banking fees:
Net gain on sale of loans		$	99,132			$	85,535			$	67,891
Title services		30,626				27,233				25,427
Servicing fees		561				553				490
		$	130,319			$	113,321			$	93,808

2017 versus 2016

Loan closing volume in 2017 increased by approximately $276,900, or 7%, from 2016. The increase was primarily attributable to a 6% increase in the number of loans closed year over year due primarily to the aforementioned increase in the homebuilding segment’s number of settlements in 2017 as compared to 2016.

Segment profit in 2017 increased by approximately $10,200, or 16%, from 2016. The increase in segment profit was primarily attributable to an increase in mortgage banking fees, partially offset by an increase in general and administrative expenses. Mortgage banking fees increased by approximately $17,000, or 15%, resulting from the aforementioned increase in loan closing volume and an increase in secondary marketing gains on sales of loans. General and administrative expenses increased by approximately $7,400, due primarily to an increase in compensation costs as a result of an increase in average headcount compared to 2016.

2016 versus 2015

Loan closing volume in 2016 increased by approximately $460,200, or 13%, from 2015. The increase was primarily attributable to a 13% increase in the number of loans closed year over year due primarily to the aforementioned increase in the homebuilding segment’s number of settlements in 2016 as compared to 2015.

Segment profit in 2016 increased by approximately $12,500, or 24%, from 2015. The increase in segment profit was primarily attributable to an increase in mortgage banking fees, partially offset by an increase in general and administrative expenses. Mortgage banking fees increased by approximately $19,500, or 21%, resulting from the aforementioned increase in loan closing volume and an increase in secondary marketing gains on sales of loans. General and administrative expenses increased by approximately $8,200, due primarily to an increase in compensation costs as a result of an increase in average headcount compared to 2015.

Mortgage Banking – Other

We sell all of the loans we originate into the secondary mortgage market. Insofar as we underwrite our originated loans to the standards and specifications of the ultimate investor, we have no further financial obligations from the issuance of loans, except in certain limited instances where early payment default occurs. Those underwriting standards are typically equal to or more stringent than the underwriting standards required by FNMA, FHLMC, VA and FHA. Because we sell all of our loans and do not service them, there is often a substantial delay between the time that a loan goes into default and the time that the investor requests us to reimburse them for losses incurred because of the default. We believe that all of the loans that we originate are underwritten to the standards and specifications of the ultimate investor to whom we sell our originated loans. We employ a quality control department to ensure that

our underwriting controls are effective, and further assess the underwriting function as part of our assessment of internal controls over financial reporting.

We maintain a reserve for losses on mortgage loans originated that reflects our judgment of the present loss exposure from the loans that we have originated and sold. The reserve is calculated based on an analysis of historical experience and exposure. At December 31, 2017, we had a repurchase reserve of approximately $14,000. Although we consider the repurchase reserve reflected on the December 31, 2017 consolidated balance sheet to be adequate, there can be no assurance that this reserve will prove to be adequate to cover losses on loans previously originated.

NVRM is dependent on our homebuilding operation’s customers for business. If New Orders and selling prices of the homebuilding segment decline, NVRM’s operations will also be adversely affected. In addition, NVRM’s operating results may be adversely affected in future periods due to tightening and volatility of the credit markets, changes in investor funding times, increased regulation of mortgage lending practices and increased competition in the mortgage market.

Seasonality

We generally have higher New Order activity in the first half of the year and higher home settlements, revenues and net income in the second half of the year.

Effective Tax Rate

Our consolidated effective tax rate in 2017, 2016 and 2015 was 36.53%, 35.73% and 36.52%, respectively. The effective tax rate in 2017 was impacted by the following items:

•	The enactment of the Tax Cuts and Jobs Act (the "Act") in December 2017, which required a remeasurement of our net deferred tax assets, resulted in a charge to income tax expense of $62,702 in the fourth quarter, and

•	Our adoption of ASU 2016-09, which resulted in the recognition of an income tax benefit of $58,681 related to excess tax benefits from stock option exercises in 2017. Excess tax benefits in 2015 and 2016 were recorded to additional paid-in capital within shareholders' equity on the consolidated balance sheet.

Excluding the charge related to the the net deferred tax asset remeasurement, our effective tax rate in 2017 would have been 29.13%.

Our effective tax rate in 2018, excluding any excess tax benefit from stock option exercises, will be favorably impacted by the change in the Federal statutory tax rate from 35% in 2017 to 21% in 2018. We expect continued rate volatility in future years attributable to the recognition of excess tax benefits from equity plan activity and distributions from the deferred compensation plans.

The Act eliminates the "performance-based compensation" exception from Section 162(m). The Act includes a grandfathering provision for compensation pursuant to a written binding contract which was in effect on November 2, 2017, and which was not modified in any material respect after such date. We believe that our outstanding equity grants and amounts in the deferred compensation plans as of December 31, 2017 are in compliance with the grandfathering provision of the Act, and thus, will remain deductible to the extent they are considered "performance-based compensation."

Recent Accounting Pronouncements Pending Adoption

In May 2014, FASB issued ASU 2014-9, Revenue from Contracts with Customers, which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The standard will replace most existing revenue recognition guidance in GAAP when it becomes effective. The standard is effective for us as of January 1, 2018. We will adopt the standard using the cumulative effect transition method. We have determined that the adoption of this standard will not have a material effect on our consolidated financial statements and related disclosures.

In February 2016, FASB issued ASU 2016-2, Leases (Topic 842), which requires lessees to recognize most leases on-balance sheet with a liability equal to the present value of lease payments over the lease term and a right-of-use asset for the right to use the underlying asset over the lease term. Lessees will recognize expenses on their income statements in a manner similar to current GAAP. The standard also requires additional disclosures of key information about leasing arrangements. The standard is effective for us as of January 1, 2019. We believe that the adoption of this standard will have a material effect on both assets and liabilities presented on the balance sheet, and are further evaluating the impact of its adoption.

In June 2016, FASB issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326), which significantly changes the way impairment of financial assets is recognized. The standard will require immediate recognition of estimated credit losses expected to occur over the remaining life of many financial assets, which will generally result in earlier recognition of allowances for credit losses on loans and other financial instruments. The standard’s provisions will be applied as a cumulative-effect adjustment to beginning retained earnings as of the effective date. The standard is effective for us as of January 1, 2020. Early adoption is permitted for annual and interim periods beginning January 1, 2019. We are currently evaluating the effect that the standard will have on our consolidated financial statements and related disclosures.

In August 2016, FASB issued ASU 2016-15, Classification of Certain Cash Receipts and Cash Payments. The objective of the standard is to address the diversity in practice of how certain cash receipts and payments are presented on the statement of cash flows. The standard requires that the guidance be applied retrospectively in the first interim and annual periods in which an entity adopts the guidance. The standard is effective for us as of January 1, 2018. We expect the standard to affect the presentation of distributions from joint ventures in our consolidated statements of cash flows.

In November 2016, FASB issued ASU 2016-18, Statement of Cash Flows (Topic 230), Restricted Cash. The amendments in the standard require that the statement of cash flows explain the change during the period in the total of cash, cash equivalents and restricted cash or restricted cash equivalents. As a result, restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total cash amounts shown on the statement of cash flows. The standard is effective for us as of January 1, 2018. We do not believe that the adoption of this standard will have a material effect on our consolidated statements of cash flows and related disclosures.

In January 2017, FASB issued ASU 2017-4, Intangibles – Goodwill and Other (Topic 350), Simplifying the Test for Goodwill Impairment. The standard’s objective is to simplify the subsequent measurement of goodwill by eliminating the second step from the goodwill impairment test. Under the amendments in the standard, an entity would perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. If the carrying amount of a reporting unit exceeds its fair value, an impairment charge would then be recognized, not to exceed the amount of goodwill allocated to that reporting unit. The standard is effective for us on January 1, 2020, and early adoption is permitted. We do not believe that the adoption of this standard will have a material effect on our consolidated financial statements and related disclosures.

In May 2017, FASB issued ASU 2017-09, Compensation – Stock Compensation (Topic 718), Scope of Modification Accounting. The amendments in the standard clarify when changes in a share-based payment award must be accounted for as a modification, and will allow entities to make certain changes to share-based payment awards without accounting for them as modifications. Under the new guidance, entities will only apply modification accounting if there are substantive changes made to share-based payment awards. If a change made to a share-based payment award does not affect the fair value, vesting conditions and classification as either an equity or liability instrument, modification accounting will not need to be applied. The standard is effective for us on January 1, 2018. We do not believe that the adoption of this standard will have a material effect on our consolidated financial statements and related disclosures.

Liquidity and Capital Resources

Lines of Credit and Notes Payable

Senior Notes

Our homebuilding segment funds its operations from cash flows provided by operating activities, a short-term unsecured working capital revolving credit facility and capital raised in the public debt and equity markets. On September 10, 2012, we completed an offering for $600,000 aggregate principal amount of 3.95% Senior Notes due 2022 under a Shelf Registration Statement filed on September 5, 2012 with the SEC. The Senior Notes were issued at a discount to yield 3.97% and have been reflected net of the unamortized discount in the accompanying consolidated balance sheet. The Senior Notes mature on September 15, 2022 and bear interest at 3.95%, payable semi-annually in arrears on March 15 and September 15.

The Senior Notes are senior unsecured obligations and rank equally in right of payment with any of our existing and future unsecured senior indebtedness, will rank senior in right of payment to any of our future indebtedness that is by its terms expressly subordinated to the Senior Notes and will be effectively subordinated to any of our existing and future secured indebtedness to the extent of the value of the collateral securing such indebtedness. The indenture governing the Senior Notes does not contain any financial covenants; however, it does contain, among other items, and subject to certain exceptions, covenants that restrict our ability to create, incur, assume or guarantee secured debt, enter into sale and leaseback transactions and conditions related to mergers and/or the sale of assets.

Credit Agreement

On July 15, 2016, we entered into an unsecured Credit Agreement (the “Credit Agreement”) with Bank of America, N.A., as Administrative Agent, Swing Line Lender and L/C Issuer, Merrill Lynch, Pierce, Fenner & Smith Incorporated as Sole Lead Arranger and Sole Book Runner, and the other lenders party thereto, which provides for aggregate revolving loan commitments of $200,000 (the “Facility”). Proceeds of the borrowings under the Facility will be used for working capital and general corporate purposes. Under the Credit Agreement, we may request increases of up to $300,000 to the Facility in the form of revolving loan commitments or term loans to the extent that new or existing lenders agree to provide additional revolving loan or term loan commitments. The Credit Agreement provides for a $100,000 sublimit for the issuance of letters of credit of which there was approximately $7,300 outstanding at December 31, 2017, and a $25,000 sublimit for a swing line commitment. Borrowings under the Credit Agreement generally bear interest for Base Rate Loans at a Base Rate equal to the highest of (i) a Federal Funds Rate plus one-half of one percent, (ii) Bank of America’s publicly announced “prime rate,” and (iii) the Eurodollar Rate plus one percent, plus the Applicable Rate which is based on our debt rating, or for Eurodollar Rate Loans, at the Eurodollar Rate equal to LIBOR plus the Applicable Rate.

The Credit Agreement contains various representations and affirmative and negative covenants that are generally customary for credit facilities of this type. Such covenants include, among others, the following financial maintenance covenants: (i) minimum consolidated tangible net worth, (ii) minimum interest coverage ratio or minimum liquidity and (iii) a maximum leverage ratio. The negative covenants include, among others, certain limitations on liens, investments and fundamental changes. The Credit Agreement termination date is July 15, 2021. We were in compliance with all covenants under the Credit Agreement at December 31, 2017. There were no borrowings outstanding under the Credit Agreement as of December 31, 2017.

Repurchase Agreement

Our mortgage banking subsidiary, NVRM, provides for its mortgage origination and other operating activities using cash generated from operations, borrowings from its parent company, NVR, as well as a revolving mortgage repurchase facility, which is non-recourse to NVR. On July 26, 2017, NVRM entered into the Ninth Amendment (the “Amendment”) to its Amended and Restated Master Repurchase Agreement dated August 2, 2011 with U.S. Bank National Association (as amended by the Amendment and eight earlier amendments, the “Repurchase Agreement”). The Repurchase Agreement provides borrowing capacity up to $150,000, subject to certain sublimits, and provides for an incremental commitment pursuant to which we may from time to time request increases in the total commitment available under the Repurchase Agreement by up to $50,000 in the aggregate. The purpose of the Repurchase Agreement is to finance the origination of mortgage loans by NVRM. The Repurchase Agreement expires on July 25, 2018. Advances under the Repurchase Agreement carry a Pricing Rate based on the LIBOR Rate plus the LIBOR Margin, as determined under the Repurchase Agreement, provided that the Pricing Rate shall not be less than 2.125%. There are several restrictions on purchased loans, including that they cannot be sold to others, they cannot be pledged to anyone other than the agent, and they cannot support any other borrowing or repurchase agreement.

The Repurchase Agreement contains various affirmative and negative covenants. The negative covenants include among others, certain limitations on transactions involving acquisitions, mergers, the incurrence of debt, sale of assets and creation of liens upon any of its Mortgage Notes. Additional covenants include (i) a tangible net worth requirement, (ii) a minimum liquidity requirement, (iii) a minimum net income requirement, and (iv) a maximum leverage ratio requirement. We were in compliance with all covenants under the Repurchase Agreement at December 31, 2017. At December 31, 2017, there was no debt outstanding under the Repurchase Agreement and there were no borrowing base limitations.

Equity Repurchases

In addition to funding growth in our homebuilding and mortgage banking operations, we historically have used a substantial portion of our excess liquidity to repurchase outstanding shares of our common stock in open market and privately negotiated transactions. This ongoing repurchase activity is conducted pursuant to publicly announced Board authorizations, and is typically executed in accordance with the safe-harbor provisions of Rule 10b-18 promulgated under the Securities Exchange Act of 1934, as amended. In addition, the Board resolutions authorizing us to repurchase shares of our common stock specifically prohibit us from purchasing shares from our officers, directors, Profit Sharing Plan Trust or Employee Stock Ownership Plan Trust. The repurchase program assists us in accomplishing our primary objective, creating increases in shareholder value. See “Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities” in Item 5 of this Form 10-K for disclosure of amounts repurchased during the fourth quarter of 2017. For the year ended December 31, 2017, we repurchased 166,520 shares of our common stock at an aggregate purchase price of $422,166. As of December 31, 2017, we had $361,693 available under Board approved repurchase authorizations.

Cash Flows

For the year ended December 31, 2017, cash and cash equivalents increased by $271,244. Net cash provided by operating activities was $568,904, due primarily to cash provided by earnings in 2017 and net proceeds of $104,848 from mortgage loan activity. Cash was primarily used to fund the increase in homebuilding inventory of $154,099, which is attributable to an increase in the number of homes under construction at December 31, 2017 compared to December 31, 2016. Net cash used in investing activities in 2017 of $16,019 was attributable to cash used for purchases of property, plant and equipment of $20,269 and investments in unconsolidated JVs of $3,800, offset partially by the receipt of capital distributions from our unconsolidated JVs totaling $7,203. Net cash used in financing activities of $281,641, was primarily impacted by our repurchase of 166,520 shares of our common stock for an aggregate purchase price of $422,166 under our ongoing common stock repurchase program as discussed above, offset partially by $140,525 in proceeds from stock option exercises.

As a result of our adoption of ASU 2016-09 in 2017, we have retrospectively adjusted the prior year cash flow presentation of excess tax benefits from stock option exercises to conform with current year presentation. See Note 1 for further discussion of the impact of the adoption of ASU 2016-09.

For the year ended December 31, 2016, cash and cash equivalents decreased by $28,697. Net cash provided by operating activities was $398,126. Cash provided by earnings in 2016 was used to fund the increase in homebuilding inventory of $85,194, as a result of an increase in units under construction at December 31, 2016 compared to December 31, 2015, and the increase of $32,280 in contract land deposits. Cash was favorably impacted by an increase of $58,532 in accounts payable and accrued expenses associated with the increase in homebuilding inventory and net proceeds of $49,981 from mortgage loan activity. Net cash used in investing

activities in 2016 of $9,428 primarily included cash used for purchases of property, plant and equipment of $22,369, offset partially by the receipt of capital distributions from our unconsolidated JVs totaling $12,594. Net cash used in financing activities of $417,395, was primarily impacted by our repurchase of 280,288 shares of our common stock for an aggregate purchase price of $455,351 under our ongoing common stock repurchase program as discussed above, offset partially by $38,106 in proceeds from stock option exercises.

For the year ended December 31, 2015, cash and cash equivalents decreased by $120,103. Net cash provided by operating activities was $226,702. Cash provided by earnings in 2015 was used to fund the increase in homebuilding inventory of $134,803, as a result of an increase in units under construction at December 31, 2015 compared to December 31, 2014, and the increase of $37,561 in contract land deposits. Cash was favorably impacted by an increase of $55,404 in accounts payable and accrued expenses associated with the increase in homebuilding inventory. Net cash used in investing activities in 2015 of $1,022 included cash used for purchases of property, plant and equipment of $18,277 and investments in our unconsolidated JVs totaling $1,917. These were partially offset by the receipt of capital distributions from our unconsolidated JVs totaling $18,489. Net cash used in financing activities was $345,783, due primarily to our repurchase of 289,687 shares of our common stock for an aggregate purchase price of $431,367, offset partially by $85,948 in proceeds from stock option exercises.

At December 31, 2017 and 2016, the homebuilding segment had restricted cash of $19,438 and $17,561, respectively. Restricted cash in each year was attributable to customer deposits for certain home sales.

We believe that our current cash holdings, cash generated from operations, and cash available under our short-term unsecured credit agreement, revolving mortgage repurchase facility and the public debt and equity markets will be sufficient to satisfy near and long term cash requirements for working capital and debt service in both our homebuilding and mortgage banking operations.

Off-Balance Sheet Arrangements

Lot Acquisition Strategy

We generally do not engage in land development. Instead, we typically acquire finished building lots at market prices from various land developers under Lot Purchase Agreements that require deposits that may be forfeited if we fail to perform under the agreement. The deposits required under the Lot Purchase Agreements are in the form of cash or letters of credit in varying amounts and represent a percentage, typically ranging up to 10%, of the aggregate purchase price of the finished lots.

We believe that our lot acquisition strategy reduces the financial requirements and risks associated with direct land ownership and land development. We may, at our option, choose for any reason and at any time not to perform under these Lot Purchase Agreements by delivering notice of our intent not to acquire the finished lots under contract. Our sole legal obligation and economic loss for failure to perform under these purchase agreements is limited to the amount of the deposit pursuant to the liquidated damage provision contained in the Lot Purchase Agreements. We do not have any financial guarantees or completion obligations and we typically do not guarantee lot purchases on a specific performance basis under these Lot Purchase Agreements.

At December 31, 2017, we controlled approximately 88,700 lots through Lot Purchase Agreements, JVs and land under development, with an aggregate purchase price of approximately $8,400,000. These lots are controlled by making or committing to make deposits of approximately $533,700 in the form of cash and letters of credit. Our entire risk of loss pertaining to the aggregate purchase price contractual commitment resulting from our non-performance under the contracts is limited to $393,900 in deposits paid and $1,900 in letters of credit issued as of December 31, 2017, plus approximately $137,900 related to deposits to be paid subsequent to December 31, 2017 assuming that contractual development milestones are met by the developers and we exercise our option, and approximately $1,500 in specific performance obligations (see Contractual Obligations section below). As of December 31, 2017, we had recorded an impairment valuation allowance of approximately $30,000 related to certain cash deposits currently outstanding. Additionally, as of December 31, 2017, we had funding commitments totaling $5,300 to three of our JVs and approximately $7,900 under a joint development agreement related to our land under development, a portion of which we expect will be offset by development credits of approximately $4,700.

In addition, we have certain properties under contract with land owners that are expected to yield approximately 10,700 lots, which are not included in our number of total lots controlled above. Some of these properties may require rezoning or other approvals to achieve the expected yield. These properties are controlled with cash deposits and letters of credit of approximately $6,600 and $100, respectively as of December 31, 2017, of which approximately $5,800 is refundable if we do not perform under the contract and the remainder is at risk of loss. We generally expect to assign the raw land contracts to a land developer and simultaneously enter into a Lot Purchase Agreement with the assignee if the project is determined to be feasible. Please refer to Note 1 in the accompanying consolidated financial statements for a further discussion of the contract land deposits and Note 3 in the accompanying consolidated financial statements for a description of our lot acquisition strategy in relation to our accounting for variable interest entities.

Bonds and Letters of Credit

We enter into bond or letter of credit arrangements with local municipalities, government agencies, or land developers to collateralize our obligations under various contracts. We had approximately $44,300 of contingent obligations under such agreements as of December 31, 2017, inclusive of the $2,000 of lot acquisition deposits in the form of letters of credit discussed above. We believe we will fulfill our obligations under the related contracts and do not anticipate any material losses under these bonds or letters of credit.

Mortgage Commitments and Forward Sales

In the normal course of business, NVRM enters into contractual commitments to extend credit to buyers of single-family homes with fixed expiration dates. The commitments become effective when the borrowers “lock-in” a specified interest rate within time frames established by us. All mortgagors are evaluated for credit worthiness prior to the extension of the commitment. Market risk arises if interest rates move adversely between the time of the “lock-in” of rates by the borrower and the sale date of the loan to a broker/dealer. To mitigate the effect of the interest rate risk inherent in providing rate lock commitments to borrowers, we enter into optional or mandatory delivery forward sale contracts to sell whole loans and mortgage-backed securities to broker/dealers. The forward sale contracts lock in an interest rate and price for the sale of loans similar to the specific rate lock commitments. We do not engage in speculative or trading derivative activities. Both the rate lock commitments to borrowers and the forward sale contracts to broker/dealers are undesignated derivatives, and, accordingly, are marked to fair value through earnings. At December 31, 2017, we had contractual commitments to extend credit to borrowers aggregating $490,184 and open forward delivery contracts aggregating $705,405, which hedge both the rate lock commitments and closed loans held for sale (see Note 14 in the accompanying consolidated financial statements for a description of our fair value accounting).

Contractual Obligations

Our fixed, non-cancelable obligations as of December 31, 2017, were as follows:

		Payments due by year
		Total				2018				2019 to 2020				2021 to 2022				2023 and Later
Debt (1)		$	600,000			$	—			$	—			$	600,000			$	—
Interest on debt (1)		111,522				23,700				47,400				40,422
Operating leases (2)		110,152				29,366				39,368				24,216				17,202
Purchase obligations (3)		147,311				*				*				*				*
Uncertain tax positions (4)		35,816				*				*				*				*
Total		$	1,004,801			$	53,066			$	86,768			$	664,638			$	17,202

(1)	See Note 9 in the accompanying consolidated financial statements for additional information regarding the Senior Notes.

(2)	See Note 13 in the accompanying consolidated financial statements for additional information regarding operating leases.

(3)

Amount represents expected payments of forfeitable deposits with land developers under existing Lot Purchase Agreements assuming that contractual development milestones are met by the developers and we exercise our option, specific performance guarantees and estimated contractual obligations for land development agreements. We expect to make the majority of payments of the deposits with land developers within the next three years, but due to the nature of the contractual development milestones that must be met we are unable to accurately estimate the portion of the deposit obligation that will be made within one year and that portion that will be made within one to three years.

(4)	Due to the nature of the uncertain tax positions, we are unable to make a reasonable estimate as to the period of settlement with the respective taxing authorities.

Critical Accounting Policies

General

The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting periods. We continually evaluate the estimates we use to prepare the consolidated financial statements and update those estimates as necessary. In general, our estimates are based on historical experience, on information from third party professionals, and other various assumptions that are believed to be reasonable under the facts and circumstances. Actual results could differ materially from those estimates made by management.

Homebuilding Inventory

The carrying value of inventory is stated at the lower of cost or market value. Cost of lots and completed and uncompleted housing units represent the accumulated actual cost of the units. Field construction supervisors’ salaries and related direct overhead expenses are included in inventory costs. Interest costs are not capitalized into inventory, with the exception of land under development. Upon settlement, the cost of the unit is expensed on a specific identification basis. Cost of building materials is determined on a first-in, first-out basis.

Sold inventory is evaluated for impairment based on the contractual selling price compared to the total estimated cost to construct. Unsold inventory is evaluated for impairment by analyzing recent comparable sale prices within the applicable community compared to the costs incurred to date plus the expected costs to complete. Any calculated impairments are recorded immediately in cost of sales.

Land Under Development and Contract Land Deposits

Land Under Development

On a limited basis, we directly acquire raw parcels of land already zoned for its intended use to develop into finished lots. Land under development includes the land acquisition costs, direct improvement costs, capitalized interest, where applicable, and real estate taxes.

Land under development, including the land under development held by our unconsolidated JVs and the related joint venture investments, is reviewed for potential write-downs when impairment indicators are present. In addition to considering market and economic conditions, we assess land under development impairments on a community-by-community basis, analyzing, as applicable, current sales absorption levels, recent sales’ direct profit, and the dollar differential between the projected fully-developed cost of the lots and the current market price for lots. If indicators of impairment are present for a community, we perform an analysis to determine if the undiscounted cash flows estimated to be generated by those assets are less than their carrying amounts, and if they are, impairment charges are required to be recorded in an 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 future cash flows at a rate commensurate with the inherent risks associated with the assets and related estimated cash flow streams.

At December 31, 2017, we had approximately $34,200 in land under development in four separate communities. In addition, at December 31, 2017, we had an aggregate investment totaling approximately $45,500 in six separate JVs that controlled land under development. None of the communities classified as land under development nor any of the undeveloped land held by the JVs had any indicators of impairment at December 31, 2017. As such, we do not believe that any of the land under development is impaired at this time. However, there can be no assurance that we will not incur impairment charges in the future due to unanticipated adverse changes in the economy or other events adversely affecting specific markets or the homebuilding industry.

Contract Land Deposits

We purchase finished lots under Lot Purchase Agreements that require deposits that may be forfeited if we fail to perform under the contract. The deposits are in the form of cash or letters of credit in varying amounts and represent a percentage of the aggregate purchase price of the finished lots.

We maintain an allowance for losses on contract land deposits that reflects our judgment of the present loss exposure in the existing contract land deposit portfolio at the end of the reporting period. To analyze contract land deposit impairments, we utilize a loss contingency analysis that is conducted each quarter. In addition to considering market and economic conditions, we assess contract land deposit impairments on a community-by-community basis pursuant to the purchase contract terms, analyzing, as applicable, current sales absorption levels, recent sales’ direct profit, the dollar differential between the contractual purchase price and the current market price for lots, a developer’s financial stability, a developer’s financial ability or willingness to reduce lot prices to current market prices, and the contract’s default status by either us or the developer along with an analysis of the expected outcome of any such default.

Our analysis is focused on whether we can sell houses at an acceptable margin and sales pace in a particular community in the current market with which we are faced. Because we do not own the finished lots on which we had placed a contract land deposit, if the above analysis leads to a determination that we cannot sell homes at an acceptable margin and sales pace at the current contractual lot price, we then determine whether we will elect to default under the contract, forfeit our deposit and terminate the contract, or whether we will attempt to restructure the lot purchase contract, which may require us to forfeit the deposit to obtain contract concessions from a developer. We also assess whether an impairment is present due to collectability issues resulting from a developer’s non-performance because of financial or other conditions.

Although we consider the allowance for losses on contract land deposits reflected on the December 31, 2017 consolidated balance sheet to be adequate (see Note 1 to the accompanying consolidated financial statements included herein), there can be no assurance that this allowance will prove to be adequate over time to cover losses due to unanticipated adverse changes in the economy or other events adversely affecting specific markets or the homebuilding industry.

Warranty/Product Liability Accruals

Warranty and product liability accruals are established to provide for estimated future costs as a result of construction and product defects, product recalls and litigation incidental to our business. Liability estimates are determined based on our judgment considering such factors as historical experience, the likely current cost of corrective action, manufacturers’ and subcontractors’ participation in sharing the cost of corrective action, consultations with third party experts such as engineers, and evaluations by our General Counsel and outside counsel retained to handle specific product liability cases. Although we consider the warranty and product liability accrual reflected on the December 31, 2017 consolidated balance sheet to be adequate (see Note 13 to the accompanying consolidated financial statements included herein), there can be no assurance that this accrual will prove to be adequate over time to cover losses due to increased costs for material and labor, the inability or refusal of manufacturers or subcontractors to financially participate in corrective action, unanticipated adverse legal settlements, or other unanticipated changes to the assumptions used to estimate the warranty and product liability accrual.

Equity-Based Compensation Expense

Compensation costs related to our equity-based compensation plans are recognized within our income statement. The costs recognized are based on the grant-date fair value. Compensation cost for equity-based grants is recognized on a straight-line basis over the requisite service period for the entire award (from the date of grant through the period of the last separately vesting portion of the grant). For the recognition of equity-based compensation expense, stock options which are subject to a performance condition are treated as a separate award from the “service-only” stock options, and compensation expense is recognized when it becomes probable that the stated performance target will be achieved. The reversal of compensation cost previously recognized for grants forfeited is recorded in the period in which the forfeiture occurs.

We calculate the fair value of our non-publicly traded employee stock options using the Black-Scholes option-pricing model. While the Black-Scholes model is a widely accepted method to calculate the fair value of options, its results are dependent on input variables, two of which, expected term and expected volatility, are significantly dependent on management’s judgment. We have concluded that our historical exercise experience is the best estimate of future exercise patterns to determine a stock option’s expected term. To estimate expected volatility, we analyze the historical volatility of our common stock over a period equal to the stock option’s expected term. Changes in management’s judgment of the expected term and the expected volatility could have a material effect on the grant-date fair value calculated and expensed within the income statement.

In addition, when recognizing stock based compensation cost related to “performance condition” stock option grants, we are required to make a determination as to whether the performance conditions will be met prior to the completion of the actual performance period. The performance metric is based on our return on capital performance during a specified three year period based on the date of stock option grant. While we currently believe that this performance condition will be satisfied at the target level and are recognizing compensation expense related to such stock options accordingly, our future expected activity levels could cause us to make a different determination, resulting in a change to the compensation expense to be recognized related to performance condition stock option grants that would otherwise have been recognized to date.

Although we believe that the compensation costs recognized in 2017 are representative of the cumulative ratable amortization of the grant-date fair value of unvested stock options outstanding, changes to the estimated input values such as expected term and expected volatility and changes to the determination of whether performance condition grants will vest, could produce widely different expense valuations and recognition.

Mortgage Repurchase Reserve

We originate several different loan products to our customers to finance the purchase of their home. We sell all of the loans we originate into the secondary mortgage market generally within 30 days from origination. All of the loans that we originate are underwritten to the standards and specifications of the ultimate investor. Insofar as we underwrite our originated loans to those standards, we bear no increased concentration of credit risk from the issuance of loans, except in certain limited instances where early payment default occurs. Those underwriting standards are typically equal to or more stringent than the underwriting standards required by FNMA, FHLMC, VA and FHA. We employ a quality control department to ensure that our underwriting controls are effectively operating, and further assess the underwriting function as part of our assessment of internal controls over financial reporting. We maintain a reserve for losses on mortgage loans originated that reflects our judgment of the present loss exposure in the loans that we have originated and sold. The allowance is calculated based on an analysis of historical experience and exposure. Although we consider the reserve for loan losses reflected on the December 31, 2017 consolidated balance sheet to be adequate (see Note 15 to the accompanying consolidated financial statements included herein), there can be no assurance that this reserve will prove to be adequate over time to cover losses due to unanticipated changes to the assumptions used to estimate the mortgage repurchase reserve.

Impact of Inflation, Changing Prices and Economic Conditions

See “Risk Factors” included in Item 1A of this Form 10-K for a description of the impact of inflation, changing prices and economic conditions on our business and our financial results. See also the discussion of the current business environment in the Overview section above.