D.R. Horton, Inc. — Q1 Fiscal 2019 Form 10-Q
Reporting period: Three months ended December 31, 2018. Financial statements are unaudited. D.R. Horton is a U.S. homebuilder operating in 84 markets across 29 states, with residential lot development through majority-owned Forestar and mortgage and title services.
Financial and operating results
| Metric | Q1 FY2019 | Prior-year period | Change / context |
|---|---|---|---|
| Revenue | $3.519 billion | $3.333 billion | Up about 6% |
| Pre-tax income | $375.7 million | $391.2 million | Down about 4%; pre-tax margin 10.7% vs. 11.7% |
| Net income attributable to D.R. Horton | $287.2 million | $189.3 million | Up 52% |
| Diluted EPS | $0.76 | $0.49 | Up 55% |
| Homebuilding revenue | $3.417 billion | $3.221 billion | Up 6%; 11,500 homes closed, up 7% |
| Home sales gross margin | 20.0% | 20.8% | Down 80 basis points |
| Net sales orders | 11,042 homes; $3.225 billion | 10,753 homes; $3.223 billion | Orders up 3%; order value essentially flat; cancellation rate 24% vs. 22% |
| Backlog | 13,565 homes; $4.036 billion | 12,294 homes; $3.764 billion | Homes up 10%; value up 7% |
| Operating cash flow | $(373.1) million | $(75.0) million | Higher cash use, principally from inventory and land investment |
The increase in reported net income mainly reflects a lower tax charge, not improved pre-tax earnings: the effective tax rate was 23.7%, compared with 51.7% in the prior-year quarter, which included a $108.7 million Tax Act-related charge. Management expects a fiscal 2019 effective tax rate of approximately 25%.
Balance sheet, debt and liquidity
- At December 31, 2018, cash and cash equivalents were $737.0 million and restricted cash was $31.3 million, down from combined cash and restricted cash of $1.506 billion at September 30, 2018.
- Total assets were $14.536 billion; inventory was $11.596 billion, up from $10.395 billion at fiscal year-end. Homes in inventory increased to 33,700 from 29,700 at September 30, including approximately 4,900 unsold completed homes.
- Notes payable were $3.342 billion, up from $3.204 billion. Total debt to total capital was 26.8%, versus 26.3% at September 30; homebuilding debt to total capital was 23.2%. Management expects the latter to remain significantly below its 35% long-term ceiling during fiscal 2019.
- The homebuilding revolver had $300 million drawn and $900.6 million available, after letters of credit. The company was in compliance with its debt covenants. A $500 million senior-note principal amount matures in March 2019.
- DHI Mortgage had $473.9 million outstanding under its mortgage repurchase facility, which matures February 22, 2019; management said it expected renewal and extension on similar terms. Forestar had no revolver borrowings and $376.6 million available.
- Stockholders’ equity was $9.125 billion. The company repurchased 4.1 million shares for $140.6 million and paid $56.0 million in dividends during the quarter.
Material changes and management commentary
- Home sales revenue increased with higher closings, but home sales gross margin fell as average home costs rose faster than selling prices. Consolidated pre-tax income and margin declined despite revenue growth.
- Management described recent moderation in housing demand amid affordability pressures and higher mortgage rates, with market conditions varying by region. It said it would adjust pricing, incentives, sales pace and inventory to local conditions, particularly through the next two quarters, which are typically the strongest seasonal demand period.
- Management cited solid economic fundamentals and limited affordable-home supply in many markets, but said demand and results could weaken with economic or employment declines, reduced affordability, higher mortgage rates or tighter lending standards. It emphasized positive annual operating cash flow as a focus; quarterly cash use increased materially.
- The company acquired Westport Homes, Classic Builders and Terramor Homes for $320.7 million during the quarter. The acquisitions added about 700 homes in inventory, 4,500 lots, control of approximately 4,300 additional lots through options, and a backlog of about 700 homes. Purchase-price allocation remained preliminary.
- Adoption of ASC 606 added $27.1 million, net of tax, to opening retained earnings; the company reported no material revenue impact for the quarter. The prior-year cash-flow presentation was also retrospectively changed to include restricted cash in the cash-flow reconciliation.
Risks, contingencies and unusual items
- Inventory and land-option charges were $8.0 million, versus $3.7 million a year earlier, including $4.2 million of community and land impairments. Management warned that weaker market conditions could lead to further impairments.
- Legal-claim reserves were $412.2 million, approximately 99% related to construction defects; warranty liabilities were $205.6 million. Management said estimates and insurance recoveries are uncertain and that it cannot reasonably estimate potential losses beyond recorded reserves.
- Homebuilding option contracts covered lots with approximately $6.9 billion of remaining purchase price and $449.1 million in deposits. A subset representing $96.5 million of purchase price had specific-performance provisions that could require purchase if sellers meet their obligations.
- Other disclosed risks include the cyclical housing market, land and lot exposure, construction-cost and labor availability, financing and interest-rate conditions, debt covenants, mortgage-market access, regulation and litigation. The company had an agreement in principle with the EPA over one alleged wetlands violation and expected a $267,000 penalty upon finalization; other EPA stormwater matters were also disclosed.
- Surety bonds totaled $1.5 billion and letters of credit $144.5 million, primarily securing performance obligations. The filing states these obligations are generally expected to be completed in the ordinary course.
Most important facts for investors to verify
- Whether margins and sales trends stabilize: monitor gross margin, orders, cancellations, backlog and completed unsold homes by region.
- Whether inventory and land investment convert into cash; quarterly operating cash use was $373.1 million and inventory increased substantially.
- How the March 2019 $500 million note maturity and February 2019 mortgage-facility maturity are refinanced or renewed.
- Whether acquisition integration, preliminary purchase accounting and added inventory and lot positions deliver expected returns.
- Changes in construction-defect reserves, warranty costs, impairment charges and the company’s exposure under land options and other contingencies.