D.R. Horton, Inc. — FY2014 Form 10-K
Business context and reporting period. This annual report covers the fiscal year ended September 30, 2014; fiscal Q4 ended on that date. D.R. Horton is a U.S. homebuilder operating in 27 states and 79 markets, with mortgage and title businesses. Homebuilding generated about 98% of FY2014 revenue.
Financial performance and position
| Metric | FY2014 | FY2013 |
|---|---|---|
| Total revenue | $8.025 billion | $6.259 billion |
| Homebuilding revenue | $7.859 billion | $6.086 billion |
| Pre-tax income | $814.2 million | $657.8 million |
| Net income | $533.5 million | $462.7 million |
| Diluted EPS | $1.50 | $1.33 |
| Home sales gross margin | 21.3% | 20.8% |
| Total homebuilding gross margin | 20.2% | 20.3% |
| Operating cash flow | $(661.4) million | $(1.229) billion |
Home closings rose 19% to 28,670; average closing price rose 9% to $272,200. Net sales orders increased 18% in homes and 27% in value to $8.309 billion. Year-end backlog rose 21% to 9,888 homes, valued at $2.859 billion, with a 7% higher average price. Financial-services revenue declined 4% to $166.4 million and pre-tax income fell 31% to $45.4 million, reflecting lower mortgage-sale gains and higher expenses.
At September 30, cash and marketable securities totaled $661.8 million, including $632.5 million in homebuilding cash. Inventory was $7.701 billion, up from $6.197 billion; total assets were $10.203 billion and equity $5.120 billion. Consolidated notes payable were $3.683 billion, including $359.2 million under the mortgage repurchase facility. Homebuilding debt-to-total-capital was 39.4%, down from 44.6%; net homebuilding debt-to-total-capital was 34.5%, down from 36.3%.
The company used $282.1 million in investing activities and generated $627.9 million from financing activities. Operating cash use reflected inventory investment: $918.2 million for construction-in-progress and finished homes and $513.6 million for land and lots. Management said existing cash and credit facilities were sufficient for near-term needs. The $975 million revolving facility had $300 million drawn and $582.3 million available after letters of credit; the mortgage repurchase facility had $359.2 million outstanding and was due to mature February 27, 2015, with renewal expected.
Fiscal Q4 results
Q4 revenue was $2.472 billion, pre-tax income $250.8 million, net income $166.3 million and diluted EPS $0.45, compared with $1.860 billion, $202.8 million, $139.5 million and $0.40, respectively, in Q4 FY2013. Q4 inventory and land-option charges were $21.3 million.
Material changes and notable items
- FY2014 homebuilding revenue increased 29% and home sales revenue 30%; home sales margin improved 50 basis points. Total homebuilding gross margin was slightly lower year over year as inventory charges more than doubled to $85.2 million from $31.1 million.
- Impairments were concentrated in the Midwest ($49.3 million, primarily Chicago) and East ($17.7 million, largely suburban Washington, D.C.). Management cited weak Chicago absorption and plans to reduce certain land positions.
- Acquisitions included Regent Homes for $34.5 million and Crown Communities for $209.6 million. Crown contributed 721 closings and $187.7 million of revenue after acquisition; the company recorded $53.6 million of acquisition goodwill.
- The $478.7 million carrying amount of 2% convertible notes converted into 38.6 million common shares. D.R. Horton also issued $500 million of 3.75% senior notes due 2019 and repaid notes maturing in 2014.
- FY2014 effective tax rate was 34.5%, versus 29.7% in FY2013. FY2013 included a benefit from valuation-allowance reductions; FY2012 net income was unusually elevated by a $713.4 million income-tax benefit.
Outlook, risks and contingencies
Management anticipated slow-to-moderate housing-demand growth, concentrated in markets with job growth, and expected to increase profitability while maintaining a strong balance sheet and liquidity position in FY2015. It cautioned that affordability pressures, moderating home-price increases and likely construction-cost increases could reduce future gross margins; margins in Q3 and Q4 FY2014 had already weakened versus prior-year quarters and the first half.
Key risks include housing and economic cycles, higher mortgage rates or tighter lending standards, land and inventory valuation, labor or material shortages, regulation and environmental constraints, and competition. The company also faces mortgage-loan sale and repurchase exposure, substantial debt and refinancing needs, and warranty and construction-defect claims. Legal-claim reserves were $456.9 million, with related insurance receivables of $138.4 million; management emphasized that actual claims and recoveries could differ materially from estimates. State deferred tax assets also depend on future taxable income; the company maintained a $31.1 million valuation allowance.
At year-end, the company reported compliance with credit-facility covenants. Its independent auditor gave unqualified opinions on the financial statements and internal control over financial reporting; Crown Communities was excluded from the internal-control assessment because of its recent acquisition. The former CEO retired effective September 30, 2014, and David Auld became CEO on October 1.
Investor verification priorities
- Track backlog conversion, cancellations (23% of gross orders in FY2014), and whether order growth translates into closings and cash generation.
- Assess margin trends against continued price moderation, construction-cost inflation, incentives and inventory impairment charges.
- Verify the renewal and capacity terms of the mortgage repurchase facility due February 2015, and monitor debt maturities and liquidity.
- Review Chicago and Washington, D.C. inventory reduction plans, impairment assumptions and remaining land-option exposure.
- Evaluate the adequacy and sensitivity of construction-defect reserves, insurance recoverables and mortgage repurchase reserves.
- Monitor acquisition integration, dilution from the convertible-note share issuance, and realization of deferred tax assets.