D.R. Horton, Inc. — Form 10-Q Summary
Reporting period: Fiscal third quarter and nine months ended June 30, 2018; year-over-year comparisons are to the corresponding 2017 periods. The statements are unaudited. D.R. Horton acquired a 75% controlling interest in Forestar on October 5, 2017, so the current-period results include Forestar only from the acquisition date and are not fully comparable.
Business context and performance
D.R. Horton is a U.S. homebuilder operating in 80 markets across 26 states, with homebuilding, land development, mortgage and title services, and other operations. Management reported generally improving housing demand, particularly for affordable homes, while noting market conditions vary by region.
| Metric | Three months ended June 30, 2018 | Nine months ended June 30, 2018 |
|---|---|---|
| Revenue | $4.44 billion, up 17% | $11.56 billion, up 16% |
| Income before income taxes | $616.2 million, up 39% | $1.45 billion, up 30% |
| Net income attributable to D.R. Horton | $453.8 million, up 57% | $994.1 million, up 37% |
| Diluted earnings per share | $1.18, versus $0.76 | $2.59, versus $1.92 |
| Consolidated pre-tax margin | 13.9%, versus 11.8% | 12.6%, versus 11.2% |
| Home sales gross margin | 21.9%, versus 19.8% | 21.2%, versus 19.8% |
Growth primarily reflected higher home closings and improved home sales margins. In the quarter, 14,114 homes closed, up 13%, and the average closing price rose 3% to $302,200. Nine-month closings increased 14% to 37,183. Net sales orders increased 12% in the quarter and 14% over nine months; the quarter-end backlog was 16,536 homes, up 9%, with a value of $5.0 billion, up 7%. Cancellation rates were 21% in both comparison periods.
Cash flow, balance sheet, debt and liquidity
- Nine-month operating cash flow was positive $306.5 million, compared with cash used of $185.7 million in 2017. Cash at June 30 was $1.18 billion, plus $58.7 million of restricted cash. Operating cash flow included substantial investment in homes and land; the period also benefited from asset-sale proceeds reported in investing activities.
- Total notes payable were $3.09 billion, versus $2.87 billion at September 30, 2017. Debt to total capital was 26.5%; homebuilding debt to total capital was 22.2%, down from 24.0% at September 30, 2017. Management said it expects homebuilding debt to capital to remain below its 35% long-term limit through fiscal 2018 and 2019.
- The $1.275 billion homebuilding revolving facility had no borrowings outstanding and approximately $1.2 billion of available capacity after letters of credit at June 30, 2018; the company was in compliance with its covenants. The mortgage repurchase facility had $526.3 million outstanding at 3.9% and matures February 22, 2019; renewal or replacement financing is important to financial-services liquidity.
- Total assets were $13.59 billion, liabilities $4.82 billion, and total equity $8.77 billion. Inventory was $10.30 billion, up from $9.24 billion at September 30, 2017.
- Cash dividends declared were $0.125 per share for the quarter. The company repurchased $74.9 million of stock during the nine months and authorized new buyback programs in July 2018.
Material changes and unusual items
- Homebuilding revenue increased 17% in the quarter and 16% over nine months. Homebuilding pre-tax income rose 42% in the quarter and 34% over nine months; home sales margins improved, while selling, general and administrative costs fell as a percentage of homebuilding revenue.
- Financial-services revenue grew 6% in both periods, but pre-tax income declined 11% in the quarter and 9% over nine months. Management attributed pressure to mortgage-market competition and lower pricing/gains relative to loan volume, alongside higher employee-related costs.
- The nine-month period included a $108.7 million tax expense from remeasuring deferred taxes after the Tax Cuts and Jobs Act. The reported effective tax rates were 26.4% for the quarter and 31.6% for nine months, compared with 35.0% and 35.1%. Excluding the remeasurement charge, management expected a fiscal 2018 effective tax rate of approximately 25%.
- Nine-month inventory and land-option charges were $42.8 million, including a $24.5 million settlement of a land-transaction dispute; the comparable 2017 charges were $19.9 million. The company also reported $14.5 million of gains on asset sales for the nine-month period. Forestar sold assets for net proceeds of $217.5 million, and D.R. Horton reported a gain on sale of a multifamily property in its Southeast region.
- Forestar contributed land-development operations and increased access to optioned lots. At quarter-end, 56% of D.R. Horton’s owned and controlled lots were controlled through options, up from 50% at September 30, 2017.
Outlook, risks and contingencies
Management said demand remained strong in most markets and expected housing demand to grow if the U.S. economy continued to improve, particularly in areas with job growth. It planned to adjust prices, incentives and sales pace to local demand and affordability, while managing rising land and construction costs. The filing provides no specific revenue, earnings, or closings guidance.
Key risks include weaker economic or housing conditions, declining affordability, higher mortgage rates or tighter lending standards, land and lot inventory exposure, rising labor and material costs, and access to mortgage financing and capital. Homebuilding inventory could require further impairment if market conditions deteriorate. The company also highlighted construction-defect and warranty exposure: warranty liabilities were $176.4 million, and legal-claim reserves were $407.8 million at June 30. Actual claims, costs, and insurance recoveries could differ materially from estimates. The company had $5.8 billion of remaining purchase price under homebuilding land and lot options, of which $74.8 million was subject to specific-performance provisions, plus $1.3 billion of surety bonds and $110.0 million of letters of credit outstanding.
Other matters include an ongoing Department of Justice inquiry into the mortgage subsidiary’s historical FHA loan underwriting and quality-control processes; no formal claim amount, penalty, or fine had been asserted. Management did not believe ordinary-course legal matters would have a material adverse effect, but stated that losses above recorded reserves could result in significant charges. The filing also notes seasonality: closings and operating income are generally greater in the third and fourth fiscal quarters.
Important facts for investors to verify
- Whether home orders, backlog conversions, cancellations, and affordability trends support continued closing growth across the company’s markets.
- How much of earnings growth is sustained by core homebuilding margins versus tax effects, Forestar consolidation, and asset-sale gains; also monitor land-dispute and impairment charges.
- Liquidity and refinancing developments for the mortgage repurchase facility due in February 2019, and Forestar’s stated pursuit of a new revolving credit facility.
- Changes in construction-defect, warranty, and insurance-recovery estimates, and the status or potential exposure from the DOJ FHA inquiry.
- Execution and financial contribution of the Forestar strategy, including related-party lot sales and the company’s $5.8 billion optioned-lot purchase commitments.