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

Overview

Demand conditions continued to improve in the overall U.S. housing market in 2017. Although the recovery in housing demand has been slow by historical standards, the growth in demand for new homes is being supported by job creation, high consumer confidence, a supportive interest rate environment, and a limited supply of new homes. Within this environment, we remain focused on driving additional gains in construction and asset efficiency to deliver higher returns on invested capital. Consistent with our positive market view and long-term business strategy, we expect to use our capital to support future growth while consistently returning funds to shareholders through dividends and share repurchases.

The nature of the homebuilding industry results in a lag between when investments made in land acquisition and development yield new community openings and related home closings. Our focus continues to be on adding volume growth to the efficiency gains we have achieved in recent years. Our prior investments are allowing us to grow the business, as evidenced by 11% growth in net new orders and a 12% increase in home sale revenues to $8.3 billion. We achieved this growth while also maintaining our focus on gross margin performance through community location, strategic pricing, and construction efficiencies.

During 2017, we opened approximately 250 new communities across our local markets as a result of increased land investment over the last few years. This volume of new community openings can present a challenge in today's environment where entitlement and land development delays are common. We have grown our investment in the business in a disciplined manner by emphasizing smaller projects and working to shorten our years of land supply, including the use of land option agreements when possible. We have also focused our land investments on closer-in locations where we think demand is more sustainable when the market ultimately moderates. We have accepted the trade-off of having to pay more for certain land positions where we can be more confident in future performance. Leveraging our increased land investments, we expect to open a similar number of new communities in 2018 as in 2017, which we expect will help our volume grow in 2018.

Our financial position provided flexibility to increase our investments in future communities while also returning funds to shareholders through dividends and expanded share repurchases. Specifically, we accomplished the following in 2017:

•	Continued land investment spending to support future growth, which contributed to a 12% increase in home sale revenues;

•	Committed to a plan we announced in May 2017 to sell select non-core and underutilized land parcels following a strategic review of our land portfolio (see Note 2 to the Consolidated Financial Statements);

•	Ended the year with a debt to total capitalization ratio of 42.0%, which is slightly above our targeted range of 30.0% to 40.0%, and a cash, cash equivalents, and restricted cash balance of $306.2 million with no borrowings outstanding under our unsecured revolving credit agreement;

•	Maintained our quarterly dividend at $0.09 per share; and

•	Repurchased $910.3 million of shares under our share repurchase plan.

The following is a summary of our operating results by line of business ($000's omitted, except per share data):

	Years Ended December 31,
	2017				2016				2015
Income before income taxes:
Homebuilding	$	865,332			$	860,766			$	757,317
Financial Services	73,496				73,084				58,706
Income before income taxes	938,828				933,850				816,023
Income tax expense	(491,607		)		(331,147		)		(321,933		)
Net income	$	447,221			$	602,703			$	494,090
Per share data - assuming dilution:
Net income	$	1.44			$	1.75			$	1.36

•	Homebuilding income before income taxes improved each year from 2015 to 2017. Revenues increased each year and overhead leverage improved, which offset declines in gross margin percentage. Homebuilding income before income taxes also reflected the following significant income (expense) items ($000's omitted):

			2017				2016				2015
Land inventory impairments (see Note 2)	Home sale cost of revenues		(88,952		)		(1,074		)		(7,347		)
Warranty claim (see Note 11)	Home sale cost of revenues		(12,389		)		—				—
Net realizable value adjustments ("NRV") - land held for sale (see Note 2)	Land sale cost of revenues		(83,576		)		(1,105		)		901
Insurance reserve adjustments (see Note 11)	Selling, general and administrative expenses		95,120				55,243				62,183
Write-offs of insurance receivables (see Note 11)	Selling, general and administrative expenses		(29,624		)		—				—
Restructuring costs from corporate office relocation and other actions	Selling, general and administrative expenses		—				(10,030		)		(3,826		)
Other expense, net		—				(11,643		)		(2,463		)
Write-offs of deposits and pre-acquisition costs (see Note 2)	Other expense, net		(11,367		)		(17,157		)		(5,021		)
Impairments of unconsolidated entities (see Note 2)	Other expense, net		(8,017		)		—				—
Applecross matter (see Note 11)	Other expense, net		—				—				(20,000		)
Settlement of disputed land transaction (see Note 11)	Other expense, net		—				(15,000		)		—
			$	(138,805	)		$	(766	)		$	24,427

For additional information on the above, see the applicable Notes to the Consolidated Financial Statements.

•

The increase in Financial Services income in 2017 compared with 2016 and 2015 was primarily due to an increase in mortgage origination volume resulting from higher volumes in the Homebuilding segment, partially offset by lower revenue per loan as the mortgage origination market has become more competitive. During 2015, we reduced our loan origination liabilities by $11.4 million, which favorably impacted Financial Services income. See Note 11.

•

Our effective tax rate was 52.4%, 35.5% and 39.5% for 2017, 2016, and 2015, respectively. The effective tax rate for 2017 reflects the impact of the Tax Act, enacted on December 22, 2017. In connection with our initial analysis of the impact of the Tax Act, we have recorded a provisional amount of net tax expense of $172.1 million in the year ended December 31, 2017 related to the remeasurement of our deferred tax balance and other effects. See Note 8.

Homebuilding Operations

The following is a summary of income before income taxes for our Homebuilding operations ($000’s omitted):

	Years Ended December 31,
	2017				FY 2017 vs. FY 2016			2016				FY 2016 vs. FY 2015			2015
Home sale revenues	$	8,323,984			12	%		$	7,451,315			29	%		$	5,792,675
Land sale revenues	57,106				58	%		36,035				(26	)%		48,536
Total Homebuilding revenues	8,381,090				12	%		7,487,350				28	%		5,841,211
Home sale cost of revenues (a)	(6,461,152		)		16	%		(5,587,974		)		32	%		(4,235,945		)
Land sale cost of revenues (b)	(134,449		)		319	%		(32,115		)		(10	)%		(35,858		)
Selling, general, and administrative expenses ("SG&A") (c)	(891,581		)		(7	)%		(957,150		)		20	%		(794,728		)
Other expense, net (d)	(28,576		)		(42	)%		(49,345		)		184	%		(17,363		)
Income before income taxes	$	865,332			1	%		$	860,766			14	%		$	757,317
Supplemental data:
Gross margin from home sales (a)	22.4		%		(260) bps			25.0		%		(190) bps			26.9		%
SG&A % of home sale revenues (c)	10.7		%		(210) bps			12.8		%		(90) bps			13.7		%
Closings (units)	21,052				6	%		19,951				16	%		17,127
Average selling price	$	395			6	%		$	373			10	%		$	338
Net new orders (e):
Units	22,626				11	%		20,326				13	%		18,008
Dollars	$	9,361,534			21	%		$	7,753,399			23	%		$	6,305,380
Cancellation rate	14		%					15		%					14		%
Active communities at December 31	790				9	%		726				17	%		620
Backlog at December 31:
Units	8,996				21	%		7,422				10	%		6,731
Dollars	$	3,979,064			35	%		$	2,941,512			20	%		$	2,456,565

(a)	Includes the amortization of capitalized interest; land inventory impairments of $89.0 million in 2017, $1.1 million in 2016, and $7.3 million in 2015 (see Note 2); and a warranty charge of $12.4 million related to a closed-out community (see Note 11) in 2017.

(b)	Includes net realizable value adjustments on land held for sale of $83.6 million, $1.1 million, and $(0.9) million in 2017, 2016, and 2015, respectively (see Note 2).

(c)

Includes write-offs of $29.6 million of insurance receivables associated with the resolution of certain insurance matters in 2017; general liability insurance reserve reversals of $95.1 million, $55.2 million and $62.2 million in 2017, 2016, and 2015, respectively (see Note 11); and restructuring costs from corporate office relocation and other actions of $10.0 million and $3.8 million in 2016 and 2015, respectively.

(d)

Includes an $8.0 million impairment of an investment in an unconsolidated entity in 2017 (see Note 2); $15.0 million in 2016 related to the settlement of a disputed land transaction; $20.0 million in 2015 resulting from the Applecross matter (see Note 11); and restructuring costs from corporate office relocation and other actions of $11.6 million and $2.5 million in 2016 and 2015, respectively. See "Other expense, net" for a table summarizing other significant items.

(e)	Net new orders excludes backlog acquired from Wieland in January 2016 (see Note 1). Net new order dollars represent a composite of new order dollars combined with other movements of the dollars in backlog related to cancellations and change orders.

Home sale revenues

Home sale revenues for 2017 were higher than 2016 by $0.9 billion, or 12%. The increase was attributable to a 6% increase in the average selling price and a 6% increase in closings. The increase in closings reflects the significant land investments we have made and the resulting increase in our active communities. These increased closings occurred despite the disruption in our operations caused by Hurricane Harvey in Houston, Texas, and Hurricane Irma in Florida, as well as permitting and other municipal approval delays in certain communities. The higher average selling price for 2017 reflected a shift toward move-up homebuyers.

Home sale revenues for 2016 were higher than 2015 by $1.7 billion, or 29%. The increase was attributable to a 10% increase in the average selling price and a 16% increase in closings. These increases reflect the impact of communities acquired from Wieland during the period, which contributed 6% to the growth in revenue, 4% to the growth in closings and 1% to the increase in average selling price. Excluding the communities acquired from Wieland, the increase in closings reflects the significant investments we made in opening new communities combined with improved demand. The increase in average selling price reflected a shift in our revenue mix toward move-up homebuyers.

Home sale gross margins

Home sale gross margins were 22.4% in 2017, compared with 25.0% in 2016 and 26.9% in 2015. Our results in 2017 include the effect of the aforementioned land inventory impairments totaling $89.0 million (see Note 2) and a warranty charge of $12.4 million (See Note 11). Combined, these factors reduced gross margin in 2017 by 120 basis points. The assets acquired from Wieland contributed 60 basis points to the decrease in 2016, primarily as the result of required fair value adjustments associated with the acquired homes in production and related lots. Gross margins remain strong relative to historical levels and reflect a combination of factors, including shifts in community mix, relatively stable pricing conditions in 2017 following strong pricing conditions in 2016 and 2015, and lower amortized interest costs (1.7%, 1.7%, and 2.4% of home sale revenues in 2017, 2016, and 2015, respectively) combined with higher house construction and land costs as the supply chain has responded to the housing recovery.

Land sales

We periodically elect to sell parcels of land to third parties in the event such assets no longer fit into our strategic operating plans or are zoned for commercial or other development. Land sale revenues and their related gains or losses vary between periods, depending on the timing of land sales and our strategic operating decisions. Land sales contributed net gains (losses) of $(77.3) million, $3.9 million, and $12.7 million in 2017, 2016, and 2015, respectively. The loss in 2017 resulted from the aforementioned net realizable value charges of $83.6 million (see Note 2).

SG&A

SG&A as a percentage of home sale revenues was 10.7% and 12.8% in 2017 and 2016, respectively. The gross dollar amount of our SG&A decreased $65.6 million, or 7%, in 2017 compared with 2016. SG&A includes the aforementioned insurance receivable write-offs of $29.6 million in 2017 and general liability insurance reserve reversals of $95.1 million and $55.2 million in 2017 and 2016, respectively, resulting from favorable claims experience (see Note 11). Excluding these items, the improvement in our year-over-year SG&A leverage was primarily attributable to cost efficiencies realized in late 2016 that continued into 2017.

SG&A as a percentage of home sale revenues was 12.8% and 13.7% in 2016 and 2015, respectively. The gross dollar amount of our SG&A increased $162.4 million, or 20%, in 2016 compared with 2015. SG&A included general liability insurance reserve reversals of $55.2 million and $62.2 million in 2016 and 2015, respectively (see Note 11). SG&A also reflects restructuring costs of $10.0 million in 2016 associated with actions taken to reduce overheads and the substantial completion of our corporate headquarters relocation from Michigan to Georgia, which began in 2013. Excluding these items, the improvement in our year-over-year SG&A leverage was even greater. The increase in gross dollar SG&A reflects the addition of field resources and other variable costs related to increased production volumes combined with higher costs related to healthcare and professional fees. Additionally, SG&A for 2016 reflects the impact of transaction and integration costs associated with the assets acquired from Wieland in January 2016 (see Note 1).

Other expense, net

Other expense, net includes the following ($000’s omitted):

	2017				2016				2015
Write-offs of deposits and pre-acquisition costs (Note 2)	$	11,367			$	17,157			$	5,021
Lease exit and related costs (a)	1,729				11,643				2,463
Amortization of intangible assets (Note 1)	13,800				13,800				12,900
Interest income	(2,537		)		(3,236		)		(3,107		)
Interest expense	503				686				788
Equity in (earnings) loss of unconsolidated entities (Note 4) (b)	1,985				(8,337		)		(7,355		)
Miscellaneous, net (c)	1,729				17,632				6,653
Total other expense, net	$	28,576			$	49,345			$	17,363

(a)	Lease exit and related costs for 2016 and 2015 resulted from actions taken to reduce overheads and the substantial completion of our corporate headquarters relocation from Michigan to Georgia, which began in 2013.

(b)	Includes an $8.0 million impairment of an investment in an unconsolidated entity in 2017 (see Note 2).

(c)	Miscellaneous, net includes a charge of $15.0 million in 2016 related to the settlement of a disputed land transaction and a charge of $20.0 million in 2015 resulting from the Applecross matter (see Note 11).

Net new orders

Net new orders increased 11% in 2017 compared with 2016. The increase resulted primarily from the higher number of active communities, which increased 9% to 790 at December 31, 2017. Net new orders in dollars increased by 21% compared with 2016 due to the growth in units combined with the higher average selling price. The cancellation rate (canceled orders for the period divided by gross new orders for the period) decreased in 2017 from 2016 at 14% and 15%, respectively. Ending backlog units, which represent orders for homes that have not yet closed, increased 21% at December 31, 2017 compared with December 31, 2016 as measured in units and increased 35% over the prior year period as measured in dollars. The higher average sales price when compared to 2016 also contributed to the higher backlog dollars.

Net new orders increased 13% in 2016 compared with 2015. The increase resulted from improved sales per community combined with selling from a larger number of active communities, which increased 17% to 726 active communities at December 31, 2016. The communities acquired from Wieland contributed to this growth in units by 4%. Excluding the Wieland assets, our growth in net new order units resulted from the higher number of active communities combined with a small improvement in sales pace per community. The cancellation rate increased slightly in 2016 from 2015 at 15% and 14%, respectively. Ending backlog units increased 10% at December 31, 2016 compared with December 31, 2015 and increased 20% as measured in dollars due to the increase in average selling price. The higher average sales price also contributed to the higher backlog dollars.

Homes in production

The following is a summary of our homes in production at December 31, 2017 and 2016:

		2017			2016
Sold		6,246			5,138
Unsold
Under construction		1,973			1,703
Completed		637			645
		2,610			2,348
Models		1,148			1,072
Total		10,004			8,558

The number of homes in production at December 31, 2017 was 17% higher compared to December 31, 2016. The increase in homes under production was due to a combination of factors, including a 9% increase in active communities and higher net new order volume, resulting in a 21% increase in ending backlog units. As part of our inventory management

strategy, we will continue to maintain reasonable inventory levels relative to demand in each of our markets, though inventory levels tend to fluctuate throughout the year.

Controlled lots

The following is a summary of our lots under control at December 31, 2017 and 2016:

		December 31, 2017									December 31, 2016
		Owned			Optioned			Controlled			Owned			Optioned			Controlled
Northeast		5,194			5,569			10,763			6,296			4,019			10,315
Southeast		15,404			11,085			26,489			16,050			8,232			24,282
Florida		18,458			11,887			30,345			22,164			8,470			30,634
Midwest		10,612			9,196			19,808			11,800			8,639			20,439
Texas		13,923			8,320			22,243			13,541			9,802			23,343
West		25,662			6,099			31,761			29,428			4,817			34,245
Total		89,253			52,156			141,409			99,279			43,979			143,258
Developed (%)		37	%		20	%		31	%		31	%		19	%		28	%

Of our controlled lots, 89,253 and 99,279 were owned and 52,156 and 43,979 were under land option agreements at December 31, 2017 and 2016, respectively. While competition for well-positioned land is robust, we continue to pursue strategic land positions that drive appropriate returns on invested capital. The remaining purchase price under our land option agreements totaled $2.5 billion at December 31, 2017. These land option agreements generally may be canceled at our discretion and in certain cases extend over several years. Our maximum exposure related to these land option agreements is generally limited to our deposits and pre-acquisition costs, which totaled $208.0 million, of which $11.8 million is refundable, at December 31, 2017.

Homebuilding Segment Operations

Our homebuilding operations represent our core business. Homebuilding offers a broad product line to meet the needs of homebuyers in our targeted markets. As of December 31, 2017, we conducted our operations in 47 markets located throughout 25 states. For reporting purposes, our Homebuilding operations are aggregated into six reportable segments:

Northeast:		Connecticut, Maryland, Massachusetts, New Jersey, New York, Pennsylvania, Virginia
Southeast:		Georgia, North Carolina, South Carolina, Tennessee
Florida:		Florida
Midwest:		Illinois, Indiana, Kentucky, Michigan, Minnesota, Missouri, Ohio
Texas:		Texas
West:		Arizona, California, Nevada, New Mexico, Washington

We also have a reportable segment for our financial services operations, which consist principally of mortgage banking and title operations. The Financial Services segment operates generally in the same markets as the Homebuilding segments.

The following table presents selected financial information for our reportable Homebuilding segments:

	Operating Data by Segment ($000's omitted)
	Years Ended December 31,
	2017				FY 2017 vs. FY 2016			2016				FY 2016 vs. FY 2015			2015
Home sale revenues:
Northeast	$	693,624			—	%		$	696,003			2	%		$	679,082
Southeast (a)	1,556,615				5	%		1,485,809				40	%		1,058,055
Florida	1,469,005				15	%		1,274,237				26	%		1,012,391
Midwest	1,435,692				16	%		1,233,110				22	%		1,012,460
Texas	1,166,843				13	%		1,033,387				23	%		840,766
West	2,002,205				16	%		1,728,769				45	%		1,189,921
	$	8,323,984			12	%		$	7,451,315			29	%		$	5,792,675
Income before income taxes (b):
Northeast (c)	$	21,190			(74	)%		$	81,991			(1	)%		$	82,616
Southeast (a)	122,532				(16	)%		145,011				(16	)%		172,330
Florida (d)	208,825				2	%		205,049				4	%		196,525
Midwest	178,231				48	%		120,159				31	%		91,745
Texas	182,862				20	%		152,355				26	%		121,329
West	229,504				2	%		225,771				33	%		169,394
Other homebuilding (e)	(77,812		)		(12	)%		(69,570		)		9	%		(76,622		)
	$	865,332			1	%		$	860,766			14	%		$	757,317
Closings (units):
Northeast	1,335				(6	)%		1,418				(5	)%		1,496
Southeast (a)	3,888				—	%		3,901				19	%		3,276
Florida	3,861				12	%		3,441				19	%		2,896
Midwest	3,696				8	%		3,418				15	%		2,961
Texas	4,107				10	%		3,726				11	%		3,357
West	4,165				3	%		4,047				29	%		3,141
	21,052				6	%		$	19,951			16	%		17,127
Average selling price:
Northeast	$	520			6	%		$	491			8	%		$	454
Southeast (a)	400				5	%		381				18	%		323
Florida	380				3	%		370				6	%		350
Midwest	388				8	%		361				6	%		342
Texas	284				2	%		277				11	%		250
West	481				13	%		427				13	%		379
	$	395			6	%		$	373			10	%		$	338

(a)	Southeast includes the acquisition in January 2016 of substantially all of the assets of Wieland (see Note 1).

(b)	Includes land-related charges of $191.9 million, $19.3 million, and $11.5 million in 2017, 2016, and 2015, respectively (see Note 2).

(c)	Northeast includes a charge of $15.0 million in 2016 related to the settlement of a disputed land transaction and a charge of $20.0 million in 2015 resulting from the Applecross matter (see Note 11).

(d)	Florida includes a warranty charge of $12.4 million in 2017 related to a closed-out community (see Note 11).

(e)

Other homebuilding includes amortization of intangible assets and capitalized interest and other items not allocated to the operating segments, including write-offs of $29.6 million of insurance receivables associated with the resolution of certain insurance matters in 2017 and general liability insurance reserve reversals of $95.1 million, $55.2 million, and $62.2 million in 2017, 2016, and 2015, respectively (see Note 11).

The following tables present additional selected financial information for our reportable Homebuilding segments:

		Operating Data by Segment ($000's omitted)
		Years Ended December 31,
		2017				FY 2017 vs. FY 2016			2016				FY 2016 vs. FY 2015			2015
Net new orders - units:
Northeast		1,460				7	%		1,361				(8	)%		1,479
Southeast (a)		4,233				11	%		3,810				10	%		3,454
Florida		4,121				15	%		3,585				13	%		3,168
Midwest		3,876				7	%		3,636				27	%		2,862
Texas		4,121				9	%		3,793				11	%		3,429
West		4,815				16	%		4,141				15	%		3,616
		22,626				11	%		20,326				13	%		18,008
Net new orders - dollars:
Northeast		$	757,679			12	%		$	674,066			—	%		$	674,637
Southeast (a)		1,691,020				14	%		1,483,139				28	%		1,160,590
Florida		1,594,367				19	%		1,340,181				16	%		1,152,705
Midwest		1,523,153				13	%		1,351,828				32	%		1,024,784
Texas		1,214,149				15	%		1,060,217				17	%		905,003
West		2,581,166				40	%		1,843,968				33	%		1,387,661
		$	9,361,534			21	%		$	7,753,399			23	%		$	6,305,380
Cancellation rates:
Northeast		12		%					11		%					12		%
Southeast (a)		12		%					15		%					10		%
Florida		12		%					12		%					11		%
Midwest		11		%					12		%					13		%
Texas		18		%					18		%					19		%
West		16		%					19		%					18		%
		14		%					15		%					14		%
Unit backlog:
Northeast		512				32	%		387				(13	)%		444
Southeast (a)		1,716				25	%		1,371				20	%		1,146
Florida		1,678				18	%		1,418				11	%		1,274
Midwest		1,487				14	%		1,307				20	%		1,089
Texas		1,426				1	%		1,412				5	%		1,345
West		2,177				43	%		1,527				7	%		1,433
		8,996				21	%		7,422				10	%		6,731
Backlog dollars:
Northeast		$	253,650			34	%		$	189,595			(10	)%		$	211,532
Southeast (a)		718,166				23	%		583,760				45	%		403,568
Florida		681,589				23	%		556,226				13	%		490,282
Midwest		588,539				17	%		501,079				31	%		382,360
Texas		449,797				12	%		402,491				7	%		375,660
West		1,287,323				82	%		708,361				19	%		593,163
		$	3,979,064			35	%		$	2,941,512			20	%		$	2,456,565

(a)	Southeast includes the acquisition of substantially all of the assets of Wieland in January 2016 (see Note 1).

The following table presents additional selected financial information for our reportable Homebuilding segments:

		Operating Data by Segment ($000's omitted)
		Years Ended December 31,
		2017				2016				2015
Land-related charges*:
Northeast		$	51,362			$	2,079			$	3,301
Southeast		55,689				3,089				3,022
Florida		9,702				715				4,555
Midwest		8,917				3,383				2,319
Texas		2,521				515				295
West		56,995				8,960				(2,615		)
Other homebuilding		6,726				595				590
		$	191,912			$	19,336			$	11,467

*	Land-related charges include land impairments, net realizable value adjustments for land held for sale, and write-offs of deposits and pre-acquisition costs. Other homebuilding consists primarily of write-offs of capitalized interest resulting from land-related charges. See Notes 2 and 3 to the Consolidated Financial Statements for additional discussion of these charges.

Northeast:

The length and complexity of the entitlement process in the Northeast have led to a lack of growth in volumes in recent years. For 2017, Northeast home sale revenues remained flat compared with 2016 due to a 6% decrease in closings offset by a 6% increase in average selling price. The decrease in closings occurred in the New England and Mid-Atlantic markets, while the increased average selling price occurred across all markets. The New England closings decrease was driven primarily by closings delayed as the result of a fire in an attached product building that was under construction and is in the process of being rebuilt. The decreased income before income taxes resulted from lower margins and increased overhead expense across all markets, combined with the aforementioned land-related charges recognized in the period (see Note 2). Net new orders increased across all markets.

For 2016, Northeast home sale revenues increased 2% compared with 2015 due to a 5% decrease in closings offset by an 8% increase in average selling price. The decrease in closings occurred in the Northeast Corridor and Mid-Atlantic markets while the increase in average selling price occurred across all markets. The decreased income before income taxes resulted from lower margins in Mid-Atlantic and increased overhead expense in both Mid-Atlantic and the Northeast Corridor. Net new orders decreased 8%, primarily in the Northeast Corridor and Mid-Atlantic. Northeast income before income taxes also includes a charge of $15.0 million related to the settlement of a disputed land transaction in 2016 and a charge of $20.0 million resulting from the Applecross matter in 2015 (see Note 11).

Southeast:

For 2017, Southeast home sale revenues increased 5% compared with 2016 due to a 5% increase in the average selling price. The increase in the average selling price occurred across all markets except Georgia, while closings decreased in Raleigh, Charlotte and Coastal Carolinas, offset by increases in Georgia and Tennessee. Income before income taxes decreased 16% primarily due to the aforementioned land-related charges, partially offset by lower overhead costs. Net new orders increased 11%, primarily in Georgia and Raleigh.

In 2016, the Southeast was significantly impacted by the acquisition of substantially all of the assets of Wieland in January 2016 (see Note 1). For 2016, Southeast home sale revenues increased 40% compared with 2015 due to an 18% increase in the average selling price combined with a 19% increase in closings. The increases in the average selling price and closings occurred across all markets. These increases were primarily due to contributions from the assets acquired from Wieland. Excluding those closings, revenues still increased compared with the prior year. The decreased income before income taxes resulted from lower gross margins combined with higher overhead costs, including transaction and integration costs associated

with the assets acquired from Wieland. Net new orders increased 10% in 2016 primarily due to the assets acquired from Wieland. While demand conditions remained favorable, we experienced some moderation in pace.

Florida:

For 2017, Florida home sale revenues increased 15% compared with 2016 due to a 3% increase in the average selling price combined with a 12% increase in closings. The increase in average selling price occurred across all markets except for North Florida, while the increased closings occurred across all markets. The increased income before income taxes for 2017 resulted primarily from higher revenues. Net new orders increased by 15% in 2017 due primarily to an increase in active communities. Both closings and new orders increased despite the disruption in our operations caused by Hurricane Irma.

For 2016, Florida home sale revenues increased 26% compared with 2015 due to a 6% increase in the average selling price combined with a 19% increase in closings. The increase in the average selling price occurred across all markets. The increased income before income taxes for 2016 resulted from higher revenues. Net new orders increased by 13% in 2016 due primarily to an increase in active communities in North and West Florida.

Midwest:

For 2017, Midwest home sale revenues increased 16% compared with the prior year period due to an 8% increase in closings combined with an 8% increase in the average selling price. The higher revenues and increased closings occurred across all markets. The increased closing volume combined with lower overhead costs led to a 48% increase in income before income taxes. Net new orders increased across all markets except for St. Louis, where we announced our decision to exit the market.

For 2016, Midwest home sale revenues increased 22% compared with the prior year period due to a 15% increase in closings combined with a 6% increase in the average selling price. The increase in closing volumes led to increased income before income taxes. Net new orders increased by 27% in 2016 compared with 2015, and occurred across all markets.

Texas:

For 2017, Texas home sale revenues increased 13% compared with the prior year period due to a 10% increase in closings combined with a 2% increase in the average selling price. The increase in average selling price occurred primarily in Central Texas and San Antonio, while the increase in closings occurred across all markets except for San Antonio. The higher revenues and higher closings led to increased income before income taxes. Net new orders increased 9% across all markets except for San Antonio. Both closings and new orders increased despite the disruption in our Houston operations caused by Hurricane Harvey.

For 2016, Texas home sale revenues increased by 23% compared with the prior year period due to an 11% increase in closings combined with an 11% increase in the average selling price. The increase in average selling price was broad-based across all markets, while the increase in closings occurred across all markets with the exception of San Antonio. The higher revenues and closings led to increased income before income taxes for 2016. Net new orders increased across all markets.

West:

For 2017, West home sale revenues increased 16% compared with the prior year period due to a 3% increase in closings combined with a 13% increase in the average selling price. The increased closings primarily occurred in Southern California, offset by a decrease in Northern California due to permitting and other municipal approval delays in certain communities. The increased average selling price occurred across all markets. Income before income taxes slightly increased due to the increased revenues and reduced overheads, partially offset by the aforementioned land-related charges recognized during the period (see Note 2). Net new orders increased by 16% in 2017 compared with 2016 due to higher order levels across all markets.

For 2016, West home sale revenues increased 45% compared with the prior year period due to a 29% increase in closings combined with a 13% increase in the average selling price. The increased closings and increased average selling price occurred across all markets. The increased income before income taxes resulted from higher revenues and gross margins in all markets except for Southern California. Net new orders increased by 15% in 2016 compared with 2015 due to higher order levels across all divisions except the Pacific Northwest and Southern California.

Financial Services Operations

We conduct our Financial Services operations, which include mortgage and title operations, through Pulte Mortgage and other subsidiaries. In originating mortgage loans, we initially use our own funds, including funds available pursuant to credit agreements with third parties. Substantially all of the loans we originate are sold in the secondary market within a short period of time after origination, generally within 30 days. We also sell the servicing rights for the loans we originate through fixed price servicing sales contracts to reduce the risks and costs inherent in servicing loans. This strategy results in owning the loans and related servicing rights for only a short period of time. Operating as a captive business model primarily targeted to supporting our Homebuilding operations, the business levels of our Financial Services operations are highly correlated to Homebuilding. Our Homebuilding customers continue to account for substantially all loan production. We believe that our capture rate, which represents loan originations from our Homebuilding operations as a percentage of total loan opportunities from our Homebuilding operations, excluding cash closings, is an important metric in evaluating the effectiveness of our captive mortgage business model. The following table presents selected financial information for our Financial Services operations ($000’s omitted):

	Years Ended December 31,
	2017				FY 2017 vs. FY 2016			2016				FY 2016 vs. FY 2015			2015
Mortgage operations revenues	$	146,358			3	%		$	142,262			27	%		$	111,810
Title services revenues	45,802				18	%		38,864				34	%		28,943
Total Financial Services revenues	192,160				6	%		181,126				29	%		140,753
Expenses (a)	(119,289		)		10	%		(108,573		)		32	%		(82,047		)
Other income (expense), net	625				18	%		531				—	%		—
Income before income taxes	$	73,496			1	%		$	73,084			24	%		$	58,706
Total originations:
Loans	14,152				6	%		13,373				17	%		11,435
Principal	$	4,127,084			11	%		$	3,706,745			27	%		$	2,929,531

(a) Includes net reserve releases for loan origination reserves of $11.4 million in 2015.

	Years Ended December 31,
	2017				2016				2015
Supplemental data:
Capture rate	79.9		%		81.2		%		82.9		%
Average FICO score	749				750				749
Loan application backlog	$	2,263,803			$	1,670,160			$	1,310,173
Funded origination breakdown:
Government (FHA, VA, USDA)	22		%		23		%		25		%
Other agency	70		%		70		%		69		%
Total agency	92		%		93		%		94		%
Non-agency	8		%		7		%		6		%
Total funded originations	100		%		100		%		100		%

Revenues

Total Financial Services revenues during 2017 increased 6% compared with 2016. The increase is primarily related to higher mortgage and title volumes resulting from increased home closings in the Homebuilding segment, partially offset by lower mortgage revenue per loan. Refinance activity has slowed in the mortgage industry, which has increased competition, pressured loan pricing, and resulted in lower revenue per loan for us in 2017. Total Financial Services revenues during 2016 increased 29% compared with 2015 due to a higher loan origination volume resulting from higher volumes in the Homebuilding segment combined with higher revenues per loan, which were largely attributable to a higher average loan size combined with favorable market conditions.

Income before income taxes

The increased income before income taxes for 2017 as compared with 2016 is due to increased revenues, especially within our title operations. The increased income before income taxes for 2016 as compared with 2015 is due to higher origination volume and an increase in revenue per loan combined with better overhead leverage along with contributions from our title operations.

During 2016 and 2015, we reduced our loan origination liabilities by net reserve releases of $0.5 million and $11.4 million, respectively, based on probable settlements of various repurchase requests and existing conditions. Such adjustments are reflected in Financial Services expenses. See Note 11 to the Consolidated Financial Statements for additional discussion.

Income Taxes

Our effective tax rate was 52.4%, 35.5% and 39.5% for 2017, 2016, and 2015, respectively. The 2017 effective tax rate differs from the federal statutory rate primarily due to the impacts of the Tax Act, state income tax expense on current year earnings, the favorable resolution of certain state income tax matters, the domestic production activities deduction, and state tax law changes. The 2016 effective tax rate exceeds the federal statutory rate primarily due to state income taxes, the reversal of a portion of our valuation allowance related to a legal entity restructuring, the favorable resolution of certain state income tax matters, the impact on our net deferred tax assets due to changes in business operations and state tax laws, and recognition of energy efficient home credits. The 2015 effective tax rate exceeds the federal statutory rate primarily due to state income taxes and the impact of changes in business operations and state tax laws to our net deferred tax assets.

Liquidity and Capital Resources

We finance our land acquisition, development, and construction activities and financial services operations using internally-generated funds supplemented by credit arrangements with third parties and capital market financing. We routinely monitor current and expected operational requirements and financial market conditions to evaluate accessing other available financing sources, including revolving bank credit and securities offerings.

At December 31, 2017, we had unrestricted cash and equivalents of $272.7 million, restricted cash balances of $33.5 million, and $764.5 million available under our revolving credit facility. We follow a diversified investment approach for our cash and equivalents by maintaining such funds with a broad portfolio of banks within our group of relationship banks in high quality, highly liquid, short-term deposits and investments.

We retired outstanding debt totaling $134.7 million, $986.9 million, and $239.2 million during 2017, 2016, and 2015, respectively. Our ratio of debt to total capitalization, excluding our Financial Services debt, was 42.0% at December 31, 2017.

Unsecured senior notes

In February 2016, we issued $1.0 billion of unsecured senior notes, consisting of $300.0 million of 4.25% senior notes due March 1, 2021, and $700.0 million of 5.50% senior notes due March 1, 2026. The net proceeds from this senior notes issuance were used to fund the retirement of $465.2 million of our senior notes that matured in May 2016, with the remaining net proceeds used for general corporate purposes. In July 2016 we issued an additional $1.0 billion of unsecured senior notes, consisting of an additional $400.0 million of the 4.25% senior notes due March 1, 2021, and $600.0 million of 5% senior notes due January 15, 2027. The net proceeds from the July senior notes issuance were used for general corporate purposes and to pay down approximately $500.0 million of outstanding debt, including the remainder of a then existing term loan facility. The senior notes issued in 2016 are unsecured obligations, and rank equally in right of payment with the existing and future senior

unsecured indebtedness of the Company and each of the guarantors, respectively. The notes are redeemable at our option at any time up to the date of maturity.

Revolving credit facility

We maintain a senior unsecured revolving credit facility (the “Revolving Credit Facility”) that matures in June 2019. The Revolving Credit Facility contains an uncommitted accordion feature that could increase the size of the Revolving Credit Facility to $1.25 billion, subject to certain conditions and availability of additional bank commitments. In October 2017, we exercised the accordion feature to increase the maximum borrowing capacity from $750.0 million to $1.0 billion. The Revolving Credit Facility also provides for the issuance of letters of credit that reduce the available borrowing capacity under the Revolving Credit Facility with a sublimit of $500.0 million at December 31, 2017. The interest rate on borrowings under the Revolving Credit Facility may be based on either the London Interbank Offered Rate ("LIBOR") or Base Rate plus an applicable margin, as defined therein. We had no borrowings outstanding and $235.5 million and $219.1 million of letters of credit issued under the Revolving Credit Facility at December 31, 2017 and 2016, respectively.

The Revolving Credit Facility contains financial covenants that require us to maintain a minimum Tangible Net Worth, a minimum Interest Coverage Ratio, and a maximum Debt-to-Capitalization Ratio (as each term is defined in the Revolving Credit Facility). As of December 31, 2017, we were in compliance with all covenants. Outstanding balances under the Revolving Credit Facility are guaranteed by certain of our wholly-owned subsidiaries. Our available and unused borrowings under the Revolving Credit Facility, net of outstanding letters of credit, amounted to $764.5 million and $530.9 million as of December 31, 2017 and 2016, respectively.

Other notes payable

Certain of our local homebuilding operations are party to non-recourse and limited recourse collateralized notes payable with third parties that totaled $20.0 million at December 31, 2017. These notes have maturities ranging up to three years, are secured by the applicable land positions to which they relate, have no recourse to any other assets, and are classified within notes payable. The stated interest rates on these notes range up to 7.30%.

Pulte Mortgage

Pulte Mortgage provides mortgage financing for the majority of our home closings by utilizing its own funds and funds made available pursuant to credit agreements with third parties. Pulte Mortgage uses these resources to finance its lending activities until the loans are sold in the secondary market, which generally occurs within 30 days.

Pulte Mortgage maintains a master repurchase agreement with third party lenders. In August 2017, Pulte Mortgage entered into an amended and restated repurchase agreement (the “Repurchase Agreement”) that extended the termination date to August 2018. The maximum aggregate commitment was $475.0 million (with a $50.0 million uncommitted accordion feature to allow for a temporary increase up to $525.0 million) during the seasonally high borrowing period from December 26, 2017 through January 11, 2018. At all other times, the maximum aggregate commitment ranges from $250.0 million to $400.0 million. The purpose of the changes in capacity during the term of the agreement is to lower associated fees during seasonally lower volume periods of mortgage origination activity. Borrowings under the Repurchase Agreement are secured by residential mortgage loans available-for-sale. The Repurchase Agreement contains various affirmative and negative covenants applicable to Pulte Mortgage, including quantitative thresholds related to net worth, net income, and liquidity. Pulte Mortgage had $437.8 million and $331.6 million outstanding under the Repurchase Agreement at December 31, 2017, and 2016, respectively, and was in compliance with its covenants and requirements as of such dates.

Share repurchase programs

In previous years, our Board of Directors authorized and announced a share repurchase program. In July 2016, our Board of Directors approved an increase of $1 billion to such authorization. We repurchased 35.4 million, 30.9 million, and 21.2 million shares in 2017, 2016, and 2015, respectively, for a total of $910.3 million, $600.0 million, and $433.7 million in 2017, 2016, and 2015, respectively, under these programs. At December 31, 2017, we had remaining authorization to repurchase $94.4 million of common shares. On January 25, 2018 our Board of Directors increased our repurchase authorization by $500.0 million.

Dividends

Our declared quarterly cash dividends totaled $110.0 million, $122.2 million, and $117.9 million in 2017, 2016, and 2015, respectively.

Cash flows

Operating activities

Our net cash provided by operating activities in 2017 was $663.1 million, compared with net cash provided by operating activities of $68.3 million in 2016 and net cash used in operating activities of $337.6 million in 2015. Generally, the primary drivers of our cash flow from operations are profitability and changes in inventory levels and residential mortgage loans available-for-sale. Our positive cash flow from operations for 2017 was primarily due to income before income taxes of $938.8 million, which included $191.9 million in non-cash land-related charges. These were partially offset by a net increase in inventories of $569.0 million resulting from ongoing land acquisition and development investment to support future growth combined with additional house inventory to support the higher backlog.

Our positive cash flow from operations for 2016 was primarily due to our income before income taxes of $933.9 million, which was largely offset by a net increase in inventories of $897.1 million resulting from increased land investment combined with a net increase in residential mortgage loans available-for-sale of $99.5 million.

Our negative cash flow from operations for 2015 was primarily due to a net increase in inventories of $917.3 million resulting from increased land investment, combined with a net increase in residential mortgage loans available-for-sale of $104.6 million, partially offset by our income before income taxes of $816.0 million.

Investing activities

Net cash used in investing activities totaled $50.2 million in 2017, compared with $471.2 million in 2016 and $34.6 million in 2015. The use of cash from investing activities in 2017 was primarily due to $32.1 million of capital expenditures and $23.0 million for investments in unconsolidated subsidiaries. The use of cash from investing activities in 2016 was primarily due to the acquisition of certain real estate assets from Wieland (see Note 1). The use of cash from investing activities in 2015 was primarily due to $45.4 million of capital expenditures and an $8.6 million increase in residential mortgage loans held for investment.

Financing activities

Net cash used in financing activities was $1.0 billion in 2017, compared with net cash provided by financing activities of $350.7 million and net cash used in financing activities of $161.6 million during 2016 and 2015, respectively. The net cash used in financing activities for 2017 resulted primarily from the repurchase of 35.4 million common shares for $910.3 million under our repurchase authorization, repayments of debt of $134.7 million, and cash dividends of $112.7 million, partially offset by net borrowings of $106.2 million under the Repurchase Agreement related to a seasonal increase in residential mortgage loans available-for-sale.

Repayments of debt were $986.9 million and $239.2 million in 2016 and 2015, respectively, offset by incremental borrowings of $63.7 million and $127.6 million under the Repurchase Agreement during 2016 and 2015, respectively. Cash provided by financing activities for 2016 resulted primarily from the proceeds of the unsecured senior notes issuance for $2.0 billion, offset by the repurchase of 30.9 million common shares for $600.0 million and cash dividend of $124.7 million. Cash used in financing activities for 2015 was offset by $498.1 million of proceeds from the previously existing term loan facility executed in 2015, and also includes dividend payments of $116.0 million, and the repurchase of common shares under our share repurchase authorization for $442.7 million.

Inflation

We, and the homebuilding industry in general, may be adversely affected during periods of inflation because of higher land and construction costs. Inflation may also increase our financing costs. In addition, higher mortgage interest rates affect the affordability of our products to prospective homebuyers. While we attempt to pass on to our customers increases in our costs through increased sales prices, market forces may limit our ability to do so. If we are unable to raise sales prices enough to

compensate for higher costs, or if mortgage interest rates increase significantly, our revenues, gross margins, and net income could be adversely affected.

Seasonality

Although significant changes in market conditions have impacted our seasonal patterns in the past and could do so again, we historically experience variability in our quarterly results from operations due to the seasonal nature of the homebuilding industry. We generally experience increases in revenues and cash flow from operations during the fourth quarter based on the timing of home closings. This seasonal activity increases our working capital requirements in our third and fourth quarters to support our home production and loan origination volumes. As a result of the seasonality of our operations, our quarterly results of operations are not necessarily indicative of the results that may be expected for the full year.

Contractual Obligations and Commercial Commitments

The following table summarizes our payments under contractual obligations as of December 31, 2017:

	Payments Due by Period ($000’s omitted)
	Total				2018				2019-2020				2021-2022				After 2022
Contractual obligations:
Notes payable (a)	$	4,725,126			$	166,783			$	351,239			$	986,125			$	3,220,979
Operating lease obligations	118,125				25,040				40,359				21,217				31,509
Total contractual obligations (b)	$	4,843,251			$	191,823			$	391,598			$	1,007,342			$	3,252,488

(a)	Represents principal and interest payments related to our senior notes and limited recourse collateralized financing arrangements.

(b)	We do not have any payments due in connection with capital lease or long-term purchase obligations.

We are subject to certain obligations associated with entering into contracts (including land option contracts) for the purchase, development, and sale of real estate in the routine conduct of our business. Option contracts for the purchase of land enable us to defer acquiring portions of properties owned by third parties and unconsolidated entities until we have determined whether to exercise our option, which may serve to reduce our financial risks associated with long-term land holdings. At December 31, 2017, we had $208.0 million of deposits and pre-acquisition costs, of which $11.8 million is refundable, relating to option agreements to acquire 52,156 lots with a remaining purchase price of $2.5 billion. We expect to acquire the majority of such land within the next two years.

We are currently under examination by various taxing jurisdictions and anticipate finalizing the examinations with certain jurisdictions within the next twelve months. The final outcome of these examinations is not yet determinable. The statute of limitations for our major tax jurisdictions remains open for examination for tax years 2005 - 2017. At December 31, 2017, we had $48.6 million of gross unrecognized tax benefits and $4.9 million of related accrued interest and penalties.

The following table summarizes our other commercial commitments as of December 31, 2017:

	Amount of Commitment Expiration by Period ($000’s omitted)
	Total				2018				2019-2020				2021-2022				After 2022
Other commercial commitments:
Guarantor credit facilities (a)	$	1,000,000			$	—			$	1,000,000			$	—			$	—
Non-guarantor credit facilities (b)	475,000				475,000				—				—				—
Total commercial commitments (c)	$	1,475,000			$	475,000			$	1,000,000			$	—			$	—

(a)	The $1.0 billion in 2019-2020 represents the capacity of our unsecured revolving credit facility, under which no borrowings were outstanding, and $235.5 million of letters of credit were issued at December 31, 2017.

(b)	Represents the capacity of the Repurchase Agreement, of which $437.8 million was outstanding at December 31, 2017. The capacity of $475.0 million is effective through January 12, 2018 after which it ranges from $250.0 million to $400.0 million until its expiration in August 2018.

(c)	The above table excludes an aggregate $1.2 billion of surety bonds, which typically do not have stated expiration dates.

Off-Balance Sheet Arrangements

We use letters of credit and surety bonds to guarantee our performance under various contracts, principally in connection with the development of our homebuilding projects. The expiration dates of the letter of credit contracts coincide with the expected completion date of the related homebuilding projects. If the obligations related to a project are ongoing, annual extensions of the letters of credit are typically granted on a year-to-year basis. At December 31, 2017, we had outstanding letters of credit of $235.5 million. Our surety bonds generally do not have stated expiration dates; rather, we are released from the bonds as the contractual performance is completed. These bonds, which approximated $1.2 billion at December 31, 2017, are typically outstanding over a period of approximately three to five years. Because significant construction and development work has been performed related to the applicable projects but has not yet received final acceptance by the respective counterparties, the aggregate amount of surety bonds outstanding is in excess of the projected cost of the remaining work to be performed.

In the ordinary course of business, we enter into land option agreements in order to procure land for the construction of houses in the future. At December 31, 2017, these agreements had an aggregate remaining purchase price of $2.5 billion. Pursuant to these land option agreements, we provide a deposit to the seller as consideration for the right to purchase land at different times in the future, usually at predetermined prices.

At December 31, 2017, aggregate outstanding debt of unconsolidated joint ventures was $59.5 million, of which $56.3 million was related to one joint venture in which we have a 50% interest. In connection with this loan, we and our joint venture partner provided customary limited recourse guaranties in which our maximum financial loss exposure is limited to our pro rata share of the debt outstanding. See Note 4 to the Consolidated Financial Statements for additional information.

Critical Accounting Policies and Estimates

The accompanying consolidated financial statements were prepared in conformity with U.S. generally accepted accounting principles. When more than one accounting principle, or the method of its application, is generally accepted, we select the principle or method that is appropriate in our specific circumstances (see Note 1 to our Consolidated Financial Statements). Application of these accounting principles requires us to make estimates about the future resolution of existing uncertainties; as a result, actual results could differ from these estimates. In preparing these consolidated financial statements, we have made our best estimates and judgments of the amounts and disclosures included in the consolidated financial statements, giving due regard to materiality.

Revenue recognition

Homebuilding – Homebuilding revenue and related profit are generally recognized when title to and possession of the property are transferred to the homebuyer. In situations where the homebuyer’s financing is originated by Pulte Mortgage, our wholly-owned mortgage subsidiary, and the homebuyer has not made an adequate initial or continuing investment, the profit on such sale is deferred until the sale of the related mortgage loan to a third-party investor has been completed. If there is a loss on the sale of the property, the loss on such sale is recognized at the time of closing.

Financial Services – Mortgage servicing fees represent fees earned for servicing loans for various investors. Servicing fees are based on a contractual percentage of the outstanding principal balance, or a contracted set fee in the case of certain sub-servicing arrangements, and are credited to income when related mortgage payments are received or the sub-servicing fees are earned. Loan origination fees, commitment fees, and certain direct loan origination costs are recognized as incurred. Expected gains and losses from the sale of residential mortgage loans and their related servicing rights are included in the measurement of written loan commitments that are accounted for at fair value through Financial Services revenues at the time of commitment. Subsequent changes in the fair value of these loans are reflected in Financial Services revenues as they occur. Interest income is accrued from the date a mortgage loan is originated until the loan is sold. Loans are placed on non-accrual status once they become greater than 90 days past due their contractual terms. Subsequent payments received are applied according to the contractual terms of the loan.

Inventory and cost of revenues

Inventory is stated at cost unless the carrying value is determined to not be recoverable, in which case the affected inventory is written down to fair value. Cost includes land acquisition, land development, and home construction costs, including interest, real estate taxes, and certain direct and indirect overhead costs related to development and construction. For those communities for which construction and development activities have been idled, applicable interest and real estate taxes are expensed as incurred. Land acquisition and development costs are allocated to individual lots using an average lot cost determined based on the total expected land acquisition and development costs and the total expected home closings for the community. The specific identification method is used to accumulate home construction costs.

We capitalize interest cost into homebuilding inventories. Each layer of capitalized interest is amortized over a period that approximates the average life of communities under development. Interest expense is allocated over the period based on the timing of home closings.

Cost of revenues includes the construction cost, average lot cost, estimated warranty costs, and closing costs applicable to the home. Sales commissions are classified within selling, general, and administrative expenses. The construction cost of the home includes amounts paid through the closing date of the home, plus an accrual for costs incurred but not yet paid, based on an analysis of budgeted construction costs. This accrual is reviewed for accuracy based on actual payments made after closing compared with the amount accrued, and adjustments are made if needed. Total community land acquisition and development costs are based on an analysis of budgeted costs compared with actual costs incurred to date and estimates to complete. The development cycles for our communities range from under one year to in excess of ten years for certain master planned communities. Adjustments to estimated total land acquisition and development costs for the community affect the amounts costed for the community’s remaining lots.

We test inventory for impairment when events and circumstances indicate that the cash flows estimated to be generated by the community are less than its carrying amount. Such indicators include gross margins or sales paces significantly below expectations, construction costs or land development costs significantly in excess of budgeted amounts, significant delays or changes in the planned development for the community, and other known qualitative factors. Communities that demonstrate potential impairment indicators are tested for impairment by comparing the expected undiscounted cash flows for the

community to its carrying value. For those communities whose carrying values exceed the expected undiscounted cash flows, we determine the fair value of the community and impairment charges are recorded if the fair value of the community’s inventory is less than its carrying value.

We generally determine the fair value of each community’s inventory using a combination of discounted cash flow models and market comparable transactions, where available. These estimated cash flows are significantly impacted by estimates related to expected average selling prices and sale incentives, expected sales paces, expected land development and construction timelines, and anticipated land development, construction, and overhead costs. The assumptions used in the discounted cash flow models are specific to each community. Due to uncertainties in the estimation process, the significant volatility in demand for new housing, the long life cycles of many communities, and potential changes in our strategy related to certain communities, actual results could differ significantly from such estimates.

Residential mortgage loans available-for-sale

In accordance with ASC 825, “Financial Instruments” (“ASC 825”), we use the fair value option for our residential mortgage loans available-for-sale. Election of the fair value option for residential mortgage loans available-for-sale allows a better offset of the changes in fair values of the loans and the derivative instruments used to economically hedge them without having to apply complex hedge accounting provisions. Changes in the fair value of these loans are reflected in revenues as they occur.

Loan origination liabilities

Our mortgage operations may be responsible for losses associated with mortgage loans originated and sold to investors in the event of errors or omissions relating to representations and warranties made by us that the loans met certain requirements, including representations as to underwriting standards, the existence of primary mortgage insurance, and the validity of certain borrower representations in connection with the loan. If a loan is determined to be faulty, we either repurchase the loan from the investors or reimburse the investors' losses (a “make-whole” payment).

Estimating the required liability for these potential losses requires a significant level of management judgment. During 2016 and 2015, we reduced our loan origination liabilities by net reserve releases of $0.5 million and $11.4 million, respectively, based on probable settlements of various repurchase requests and existing conditions. Reserves provided (released) are reflected in Financial Services expenses. Given the ongoing volatility in the mortgage industry, changes in values of underlying collateral over time, and other uncertainties regarding the ultimate resolution of these claims, actual costs could differ from our current estimates.

Allowance for warranties

Home purchasers are provided with a limited warranty against certain building defects, including a one-year comprehensive limited warranty and coverage for certain other aspects of the home’s construction and operating systems for periods of up to (and in limited instances exceeding) 10 years. We estimate the costs to be incurred under these warranties and record a liability in the amount of such costs at the time revenue is recognized. Factors that affect our warranty liability include the number of homes sold, historical and anticipated rates of warranty claims, and the projected cost per claim. We periodically assess the adequacy of our recorded warranty liability for each geographic market in which we operate and adjust the amounts as necessary. Actual warranty costs in the future could differ from our estimates.

Income taxes

We evaluate our deferred tax assets each period to determine if a valuation allowance is required based on whether it is "more likely than not" that some portion of the deferred tax assets would not be realized. The ultimate realization of these deferred tax assets is dependent upon the generation of sufficient taxable income during future periods. We conduct our evaluation by considering all available positive and negative evidence. This evaluation considers, among other factors, historical operating results, forecasts of future profitability, the duration of statutory carryforward periods, and the outlooks for the U.S. housing industry and broader economy. The accounting for deferred taxes is based upon estimates of future results. Differences between estimated and actual results could result in changes in the valuation of our deferred tax assets that could have a material impact on our consolidated results of operations or financial position. Changes in existing tax laws could also affect actual tax results and the realization of deferred tax assets over time. While we continue to evaluate the effects of the Tax Act enacted in December 2017, including the remeasurement of our deferred tax assets and liabilities, we reduced our deferred tax assets by $172.1 million in 2017 to reflect the lower U.S. corporate income tax rate.

Unrecognized tax benefits represent the difference between tax positions taken or expected to be taken in a tax return and the benefits recognized for financial statement purposes. We follow the provisions of ASC 740, “Income Taxes” (“ASC 740”), which prescribes a minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. Significant judgment is required to evaluate uncertain tax positions. Our evaluations of tax positions consider a variety of factors, including changes in facts or circumstances, changes in law, correspondence with taxing authorities, and effective settlements of audit issues. Changes in the recognition or measurement of uncertain tax positions could result in material increases or decreases in income tax expense (benefit) in the period in which the change is made. Interest and penalties related to income taxes and unrecognized tax benefits are recognized as a component of income tax expense (benefit).

Self-insured risks

At any point in time, we are managing over 1,000 individual claims related to general liability, property, errors and omission, workers compensation, and other business insurance coverage. We reserve for costs associated with such claims (including expected claims management expenses) on an undiscounted basis at the time product revenue is recognized for each home closing and periodically evaluate the recorded liabilities based on actuarial analyses of our historical claims. The actuarial analyses calculate estimates of the ultimate cost of all unpaid losses, including estimates for incurred but not reported losses ("IBNR"). IBNR represents losses related to claims incurred but not yet reported plus development on reported claims.

Our recorded reserves for all such claims totaled $758.8 million and $831.1 million at December 31, 2017 and 2016, respectively, the vast majority of which relate to general liability claims. The recorded reserves include loss estimates related to both (i) existing claims and related claim expenses and (ii) IBNR and related claim expenses. Liabilities related to IBNR and related claim expenses represented approximately 65% and 70% of the total general liability reserves at December 31, 2017 and 2016, respectively. The actuarial analyses that determine the IBNR portion of reserves consider a variety of factors, including the frequency and severity of losses, which are based on our historical claims experience supplemented by industry data. The actuarial analyses of the reserves also consider historical third party recovery rates and claims management expenses. Because of the inherent uncertainty in estimating future losses related to these claims, actual costs could differ significantly from estimated costs. Based on the actuarial analyses performed, we believe the range of reasonably possible losses related to these claims is $650 million to $875 million. While this range represents our best estimate of our ultimate liability related to these claims, due to a variety of factors, including those factors described above, there can be no assurance that the ultimate costs realized by us will fall within this range.

Housing market conditions have been volatile across most of our markets over the past ten years, and we believe such conditions can affect the frequency and cost of construction defect claims. Additionally, IBNR estimates comprise the majority of our liability and are subject to a high degree of uncertainty due to a variety of factors, including changes in claims reporting and resolution patterns, third party recoveries, insurance industry practices, the regulatory environment, and legal precedent. State regulations vary, but construction defect claims are reported and resolved over an extended period often exceeding ten years. Changes in the frequency and timing of reported claims and estimates of specific claim values can impact the underlying inputs and trends utilized in the actuarial analyses, which could have a material impact on the recorded reserves. Additionally, the amount of insurance coverage available for each policy period also impacts our recorded reserves. Because of the inherent uncertainty in estimating future losses and the timing of such losses related to these claims, actual costs could differ significantly from estimated costs.

Adjustments to reserves are recorded in the period in which the change in estimate occurs. During 2017, 2016, and 2015, we reduced general liability reserves by $95.1 million, $55.2 million, and $29.6 million, respectively, as a result of changes in estimates resulting from actual claim experience observed being less than anticipated in previous actuarial projections. The changes in actuarial estimates were driven by changes in actual claims experience that, in turn, impacted actuarial estimates for potential future claims. These changes in actuarial estimates did not involve any changes in actuarial methodology but did impact the development of estimates for future periods, which resulted in adjustments to the IBNR portion of our recorded liabilities. During 2015, we also recorded a general liability reserve reversal of $32.6 million, resulting from a legal settlement relating to plumbing claims initially reported to us in 2008 and for which our recorded liabilities were adjusted over time based on changes in facts and circumstances. These claims ultimately resulted in a class action lawsuit involving a national vendor and numerous other homebuilders, homebuyers, and insurance companies. In 2015, a global settlement was reached, pursuant to which we funded our agreed upon share of settlement costs, which were significantly lower than our previously estimated exposure.

In certain instances, we have the ability to recover a portion of our costs under various insurance policies or from subcontractors or other third parties. Estimates of such amounts are recorded when recovery is considered probable. Our receivables from insurance carriers totaled $213.4 million and $307.3 million at December 31, 2017 and 2016, respectively, and

we recorded write-offs of $29.6 million of insurance receivables associated with the resolution of certain insurance matters in 2017. The insurance receivables relate to costs incurred or to be incurred to perform corrective repairs, settle claims with customers, and other costs related to the continued progression of both known and anticipated future construction defect claims that we believe to be insured related to previously closed homes. We believe collection of these insurance receivables is probable based on the legal merits of our positions after review by legal counsel, favorable legal rulings received to date, the credit quality of our carriers, and our long history of collecting significant amounts of insurance reimbursements under similar insurance policies related to similar claims, including significant amounts funded by the above carriers under different policies. While the outcome of these matters cannot be predicted with certainty, we do not believe that the resolution of such matters will have a material adverse impact on our results of operations, financial position, or cash flows.