D.R. Horton, Inc. — Q3 FY2015 Form 10-Q
Business context and reporting period. The filing covers the quarter and nine months ended June 30, 2015. D.R. Horton builds and sells homes in 79 markets across 27 states and also provides mortgage and title services, primarily to its homebuyers.
Financial performance and position
| Metric | Q3 FY2015 | Prior-year comparison |
|---|---|---|
| Total revenue | $2.95 billion | $2.15 billion; up 37% |
| Net income | $221.4 million | $113.1 million; up 96% |
| Diluted EPS | $0.60 | $0.32 |
| Homebuilding revenue | $2.88 billion | $2.10 billion; up 37% |
| Homebuilding pre-tax income | $302.1 million | $158.6 million; up 90% |
| Financial services pre-tax income | $31.7 million | $13.2 million; up 140% |
| Home sales gross margin | 19.9% | 20.7%; down 80 basis points |
For the nine months, revenue was $7.65 billion, net income $511.8 million and diluted EPS $1.39, up 38%, 39% and 32%, respectively, year over year. Home sales gross margin for the nine months was 19.8%, down 190 basis points. Management attributed margin pressure mainly to home costs rising faster than selling prices.
Cash flow and liquidity: Operating cash flow was $188.6 million for the nine months, versus cash used of $573.7 million a year earlier. Q3 operating cash flow was $357.4 million, compared with cash used of $307.9 million in the prior-year quarter. June 30 cash and equivalents totaled $805.6 million, including $766.7 million in homebuilding. Homebuilding inventory was $8.11 billion, up from $7.70 billion at September 30, 2014.
Debt and capital: Homebuilding notes payable were $3.37 billion; the separately financed mortgage repurchase facility had $448.0 million outstanding. Homebuilding debt-to-total-capital was 37.5%, and net homebuilding debt-to-total-capital was 31.6%, compared with 39.4% and 34.5%, respectively, at September 30, 2014. The $975 million revolving credit facility had no borrowings and $880.7 million available after letters of credit. The company reported compliance with debt covenants.
Material changes and operating trends
- Q3 homes closed increased 28% to 9,856; average closing price rose 7% to $290,000. Nine-month closings increased 30% to 26,072.
- Q3 net sales orders rose 22% by units and 25% by value; backlog increased 12% to 12,761 homes, valued at $3.74 billion. The Q3 cancellation rate was 22%, versus 24%.
- Revenue and earnings growth reflected higher closings, expanded operations and market-share gains, as well as improved SG&A leverage and financial-services results. Crown Communities, acquired in May 2014, contributed to East and Southeast growth.
- Inventory and land option charges fell to $15.4 million in Q3 from $56.8 million. Nine-month charges were $34.0 million versus $63.9 million.
- Financial-services revenue rose 69% in Q3. Mortgage gains benefited from improved secondary-market execution and higher average loan amounts; 84% of nine-month loans sold went to three major financial entities.
Outlook, risks and unusual items
Management described housing demand as stable to moderately improved overall, with meaningful variation by market. It expected slow-to-moderate housing-demand growth, concentrated in markets with job growth, and said increased investment was expected to support revenue and profitability growth during the remainder of FY2015 and FY2016; land and lot inventories were expected to remain relatively stable. This is directional commentary, not quantified earnings guidance. Management emphasized optimizing pricing, sales pace, product mix, inventory returns and cash flow.
- Risks include weaker economic or housing conditions, reduced affordability, higher mortgage rates or tighter lending, construction-cost and labor pressures, land inventory risk, debt and covenant exposure, and the ability to access mortgage and capital-market financing.
- Construction-defect and other legal reserves were $450.7 million at June 30, 2015, with approximately 99% related to construction defects. Insurance-recovery receivables were $129.6 million. Management said outcomes and recoveries are uncertain and could differ significantly from estimates; it could not reasonably estimate potential losses beyond recorded reserves.
- Warranty liability was $77.4 million. The company recorded $23.6 million of inventory impairments for the nine months, including $7.4 million in Q3 related to a strategic decision to sell land in the West.
- The company acquired Pacific Ridge Homes in April for $70.9 million cash, with $2.0 million paid after quarter-end. It also issued $500 million of 4.0% senior notes due 2020 and repaid $157.7 million of 5.25% notes due in February 2015.
- EPA notices concerning stormwater compliance at certain Southeast sites were at an early stage. The company expected any monetary sanctions would not be material but had not recorded a liability because costs could not be reasonably estimated.
Important facts for investors to verify
- Whether sales growth and backlog convert to closings without further erosion in home sales margins, given rising home and land costs.
- Whether operating cash generation remains positive as the company manages home and land investment; nine-month operating cash flow improved substantially from the prior year.
- Homebuilding and mortgage-facility debt, refinancing needs, available revolver capacity and covenant compliance.
- Changes in construction-defect claims, legal reserves and insurance recoveries, including any losses beyond current estimates.
- Mortgage-sale execution and counterparty concentration, along with the renewal and capacity of DHI Mortgage’s repurchase facility, which matures in February 2016.