D.R. Horton, Inc. — Form 10-Q summary
Business context and period. The filing covers the third quarter and first nine months of fiscal 2017, ended June 30, 2017, with comparisons to the corresponding 2016 periods. D.R. Horton builds and sells homes across 79 markets in 26 states and also operates mortgage, title and other businesses.
Financial performance
| Metric | Three months ended June 30 | Nine months ended June 30 |
|---|---|---|
| Total revenues | $3.776 billion, up 17% | $9.932 billion, up 18% |
| Net income | $289.0 million, up 16% | $725.1 million, up 20% |
| Diluted EPS | $0.76, versus $0.66 | $1.92, versus $1.61 |
| Pre-tax income / margin | $444.5 million / 11.8% | $1.117 billion / 11.2% |
| Homebuilding revenue | $3.685 billion, up 17% | $9.675 billion, up 18% |
| Home sales gross margin | 19.8%, down 0.5 percentage point | 19.8%, down 0.3 percentage point |
| Financial services and other pre-tax income | $29.3 million, versus $30.2 million | $85.0 million, versus $61.1 million |
Homes closed increased 16% in both comparison periods: 12,497 in the quarter and 32,586 year to date. Net sales orders rose 11% in the quarter and 13% year to date. Quarter-end backlog was 15,161 homes, up 3%, valued at $4.645 billion, up 6%.
Cash flow and liquidity. Operating activities used $190.8 million in the first nine months, compared with $88.6 million provided in 2016. Cash use reflected investment in homes under construction and land/lot inventory. Investing activities used $121.0 million; financing activities used $479.0 million. Cash and cash equivalents were $512.4 million at June 30, down from $1.303 billion at September 30, 2016. Homebuilding cash was $460.8 million; financial services and other cash was $51.6 million.
Homebuilding notes payable were $2.453 billion, down from $2.798 billion at September 30, 2016. Homebuilding debt to total capital was 24.8%, versus 29.2%. The company reported no revolver borrowings and $899.9 million of available capacity after letters of credit. DHI Mortgage had $473.4 million outstanding on its mortgage repurchase facility. Total equity was $7.437 billion.
Material changes and management outlook
- Growth was driven mainly by higher home closings; homebuilding pre-tax income rose 19% in the quarter and 20% year to date. Home sales margin nevertheless narrowed, in part because warranty and construction-defect costs increased relative to revenue.
- Management described demand as stable to moderately improved in most markets, but uneven by location. It expects slow to moderate housing-demand growth if the U.S. economy continues to improve, while noting that market conditions will vary.
- Management expects fiscal 2017 SG&A as a percentage of homebuilding revenue to be below fiscal 2016 and, based on current conditions, expects homebuilding gross margins to remain relatively stable. These are expectations, not formal earnings guidance.
- Inventory increased to $9.554 billion from $8.341 billion at September 30, 2016; owned and controlled lots rose to 252,100 from 204,500. The company said it remains focused on inventory returns, positive annual operating cash flow, liquidity and debt control.
- On June 29, 2017, the company agreed to acquire 75% of Forestar for approximately $560 million in cash consideration, subject to Forestar shareholder approval and customary conditions. Closing was expected in fiscal 2018’s first quarter. Management said the deal is intended to expand land-developer relationships and increase optioned land and lots.
Risks, contingencies and unusual items
- Legal-claim reserves were $453.5 million, up from $423.5 million at fiscal year-end; about 96% related to construction defects. Nine-month legal-contingency expense was $80.6 million versus $34.2 million. Management cautioned that actual claims and insurance recoveries could differ materially from estimates.
- Warranty liabilities were $120.3 million, compared with $93.7 million a year earlier. Additional inventory impairment and land-option write-offs remain possible if market or community prospects deteriorate.
- Land and lot option contracts had approximately $4.5 billion of remaining purchase price, supported by $201.0 million of deposits. A limited group of contracts, with $30.1 million of remaining purchase price, had specific-performance provisions.
- The mortgage repurchase facility matures in February 2018; financial-services liquidity depends on renewal, extension or replacement financing. The filing reports compliance with applicable debt and facility covenants at June 30.
- Management cited risks including weaker economic or housing demand, reduced affordability, higher mortgage rates or tighter lending standards, land and construction-cost exposure, credit-market constraints, regulatory matters, and execution of the proposed Forestar transaction.
- Two IRS tax-accounting-method requests were approved during the quarter, reducing taxes payable by $58.2 million, reducing deferred tax assets by $63.5 million and increasing tax expense by $5.3 million. A third request remained pending.
- The company disclosed ongoing DOJ communications concerning historical FHA-loan underwriting and quality-control processes; the DOJ had not asserted a formal claim amount, penalty or fine. It also described an EPA stormwater matter, which it did not believe would result in a material loss.
Important facts for investors to verify
- Whether sales orders, backlog conversion and closings sustain growth, especially as conditions differ by region.
- Whether homebuilding margins hold up amid rising warranty and construction-defect costs, and whether legal and warranty reserves prove adequate.
- How inventory and land commitments affect cash generation, including progress toward management’s stated goal of positive annual operating cash flow.
- Completion, financing and expected strategic benefits of the Forestar transaction, including its cash requirements and shareholder-approval conditions.
- Renewal or replacement of DHI Mortgage’s repurchase facility before its February 2018 maturity, and any developments in the DOJ, EPA or IRS matters.